This past weekend, I attended a college basketball game at the Carrier Dome in Syracuse, NY. The Orange were taking on my alma mater, Pitt Panthers, in a highly anticipated matchup of two NCAA Tournament hopefuls. I struck up a conversation with a gentleman named Rick.

Rick is 60 years old and looking to retire in the next 3-5 years; and naturally, when I told him what I do for a living, he conveyed his frustrations and fears about what has been going on recently. Two things he said really stood out to me.

“I don’t know if I can withstand another five percent loss in my portfolio.”

Hearing this was very concerning to me. First, Rick should be planning for his retirement savings to last for another 20 or even 30 years, because there’s a 44 percent chance either Rick or his spouse will live to age 90 — and an 87 percent chance either of them lives to age 80. If your goal is a safe, comfortable retirement, then you should be looking for your investments to produce a positive real return (i.e. net of inflation).

Over time, we know that stocks are the key to maximizing your purchasing power and we know that stocks are volatile in the short-term. Longevity-risk may be the biggest risk to Rick's financial future, rather than his portfolio falling five percent in the short-term.

Source: Vanguard, assumes both Rick & Spouse are age 60.

Second, a five percent loss in his portfolio is going to happen quite often over the long-term. Since 1980, the S&P 500 has produced an annualized total return of 8.5%, but in order to achieve those gains, you had to withstand some volatile markets. In fact, over that time period, the S&P 500 dropped an average of 13.9% at some point in each year. The truth is, Rick will have to take some risk to reap the long-term rewards of the equity market.


Source: FactSet, Standard & Poor's, J.P. Morgan Asset Management

It sounds like Rick isn’t even sure what amount of risk he is taking (i.e. amount of stocks versus bonds). Risk tolerance is comprised of two components: (1) Willingness to take risk and (2) Ability to take risk. It’s clear that Rick has the ability to take risk (planning for his portfolio to last 30 years), but he may not have the same willingness to do so.

Our conversation then shifted to his financial plan. I asked him whether he has a financial plan in place and, if so, what level of equity risk is he taking — driving the point that maybe his equity risk level was not properly aligned with what appeared to be his super-low risk tolerance.

“I’m not sure, my guy has got me in a bunch of different funds.”

As a Fiduciary Investment Advisor, this statement was even more scary than his previous comment. Why? First, I believe every individual should have a financial plan. Think of it as a blueprint for the dream home you want to build. You can dream about the layout, paint colors, and décor as much as you want; but without a written plan, it will never get done.

Second, it is crucial for advisors to educate their clients about setting reasonable expectations for the risks and returns of the investment portfolio. That means being transparent about the types of asset classes held, as well as what risk and returns can reasonably be expected. “Owning a bunch of different funds” is unacceptable because if the client isn’t even sure what level of risk he’s taking, his advisor probably doesn’t either.


*Our 7-10 year forecast for risk and return of a variety of portfolio risk levels. Blended return (%) is the expected annualized return for each portfolio. Blended standard deviation (%) is the expected risk for each portfolio.

If I were Rick’s advisor, I would analyze his total financial situation, build a comprehensive financial plan that addresses both his short- and long-term goals, and then match those goals with his current (and expected) financial resources. Next, I would educate Rick on the inherent risk and returns of various investment portfolios to determine his comfort level for risk — all BEFORE revealing the details of his financial plan. Why? Because willingness always trumps ability.

If I were to build a financial plan that was too “volatile” for Rick, there’s a good chance he would lose sleep and potentially panic when he saw his portfolio fall in value. Conversely, we would find the most suitable asset allocation that balances his personal risk tolerance with the needs of his financial plan.

And once we agreed upon the plan, monitored his investment portfolio (Is this matching our expectations for risk/return?), and updated the financial plan (Have your goals changed? Given what’s happened to the portfolio, are we still on track?), the process would be on-going and navigated together to retirement and beyond. If I were your advisor...