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High Return Investment Risk


Let's have a quick chat about steps that you should take to manage high return investment risk. Whether you are managing retirement investments, trying to figure out your retirement income planning needs based on investments within your portfolio, it is important to always keep in mind that with investing, risk and reward are opposites sides of the same coin.

 

Many investors compare the performance of their portfolio to a popular index such as the S&P 500. If the index is up, say 10% in a given year then one question that investors might to consider is, how much of the upside (i.e. “up capture”) of the index did their portfolio capture? Conversely, if the index is down by -10% in a year (or over a period of time) investors should be concerned with what percentage of the negative performance of the market did their portfolio capture (i.e. “down capture”), as compared to the S&P 500? I like to refer to this as "High Return Investment Risk."

Know Your Investment Policy

Truth is, you cannot separate one from the other. If you want those high returns, then you are going to have to accept the accompanying risk, hence the need for a well written investment policy that reflects your risk tolerance, income needs and other goals. The importance of this should not be understated because investors are paying for either outcome positive or negative; whether the payment is solely reflected in the expense ratio of a particular mutual fund or exchange traded fund, a commission that is being paid to a financial advisor to purchase shares of a particular investment on behalf of the client, or if the payment is expressed as an annual percentage, based on the value of the assets that is being managed on behalf of an investor by a financial advisor.

 

The Value Of Having A Written Investment Policy Statement

 

Perhaps the best way to figure this out is by sitting down with your financial advisor and drafting an Investment Policy Statement (IPS). The purpose of an IPS is to outline the general or specific values, needs and goals that you have for investment portfolio. The IPS should also outline the investment strategy of the financial advisor or money manager, including the appropriate risk tolerance, asset class diversification and liquidity needs of the investor. I like to think of the IPS as a way to anchor an investment portfolio to my client’s values, needs and goals. When viewed in this regard, it becomes an indispensable guide to making thoughtful and suitable investment decisions; as well as helping investors to determine whether the risk is worth the potential reward.

What Is A Suitable Risk Premium For Your Investment Portfolio?

As an investor you must decide whether or not you are getting your money’s worth. For example, if you own stocks or equity based mutual funds, the expectation is that these investments will outperform a more conservative investment such as a government bond (or bond funds). We refer to the difference in portfolio returns between these two types of investments as “risk premium.” Therefore, the question that you should ask yourself is, what is a suitable risk premium for my investment portfolio?

 

Martin A. Smith is the Presidet of Wealthcare Financial Group, Inc. a retirement planning and investment advisory firm. He is also a personal finance blogger for Answers About Wealth.

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