We recently worked with an investor who grew his money through diligent saving and asset management, where his portfolio was invested based on his risk tolerances and investment time horizon. He believed that financial plans were for those with goals like sending children to college or buying homes. His only goal was retirement. Once he reached that goal, he assumed the hard part was over.
In reality, this is where the work begins.
If given the choice between a 15% average annual return or knowing that your assets will last through your life expectancy—which would you choose? Many people would jump at the 15% return. However, by chasing this high return, investors are likely putting their assets at unnecessary risk. Remember the correlation between risk and reward?
Generally, the higher your potential returns, the riskier the investment. Think about initial public offerings or hedge funds that short stocks. You have the potential to make a lot of money, but the tradeoff is the higher chance of potential loss as well. Likewise, the more conservative investments will likely produce lower returns, but they are also more likely to help protect your principal. Look at Treasury bonds—backed by the full faith and credit of the U.S. Government, but they have lower returns.
For most investors, the goal is to maximize returns without taking on an inappropriate level or type of risk. Once you retire and are living solely off your assets, at minimum, your goal is to have your assets last throughout your lifetime. To know if your money will last, you need to project your returns against your estimated spending. Furthermore, these projections need to be revisited as your spending changes because of increased health care costs, a significant change in market conditions, or changes to your marital status, just to name a few. These cash flow projections can provide you estimates on how much you can spend or what return you need to earn to maintain your level of spending.
Would you want to take on the risk of blindly chasing a 15% return, or would you rather know how much you spend a year, what your max spending could be without derailing your plan, and realize that you only need to achieve a 6% return on your investments for them to last through your life expectancy?
Both investors and advisers compare their performance to the overall market to benchmark how they are doing. But that should not be the end of the comparison. You should consider the risk you are taking to achieve those returns. To be successful, you only need a growth rate that will allow you to achieve your financial goals. That optimal rate of return is driven by your financial plan. With a plan in place, you and your financial adviser have an idea of what return is needed to achieve those goals. Quite often, it is a realistic rate of return; therefore, there is no need to take on the risk required to achieve a return of 15% a year.
If you have questions on how much risk you are taking with your portfolio, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166
This article is for demonstrative and academic purposes and is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
