Build A Robust Portfolio

A guiding principle should be that the potential for returns needs to outweigh the likelihood of losses

- David Thornton

We’ve all heard the saying – with greater risk comes the potential for greater returns. While this adage holds true for the most part, understanding different kinds of risks and how to mitigate them is more nuanced than taking a pot-luck guess at how much of it you can stomach.

Know what they are

SEQUENCE OF RETURNS

Sequencing risk is when investment market volatility meets with the cash flow coming in or out of your investment portfolio (see figure). When there is no volatility, the sequence in which you receive your investment returns won’t matter. Conversely, when there is no cash flow, every dollar of your initial investment experiences every return, be it positive or negative, so again sequence won’t matter.

However, when there are cash flows, the sequence will matter as not every invested dollar will experience the return from every period – new inflows miss the earlier returns and outflows miss any subsequent returns. The sequence of returns is a critical risk for investors nearing the end of their working years or in retirement.

“The path of returns [for retirement] is often overlooked due to a focus on asset class averages and portfolio returns,” says Michael Armitage, from the FundlLab consultancy.

“The impact of loss at the beginning of retirement, as principal is also being reduced to fund retirement, conspires to destroy retirement plans. Investors no longer contributing to their savings and drawing down capital as markets fall will quickly reduce the longevity of their assets for retirement.”

EMOTIONAL RISK