Financial Insights

Risk Tolerance, Risk Capacity & Hitting It Down the Fairway

Last weekend as I was sitting on the tee box of a rather long Par 5 at my favorite golf course, I had a driver in my hand ready to swing away and hit the ball as far as possible. While the idea was initially appealing and felt great, I had to take a step back and consider smart course management. Out of bounds all along the right side, thick rough on the left side and water near the potential landing zone. Is this the smart play? How can I minimize the potential for loss (of stroke) and keep it down the fairway towards the green? It was at that moment; I took out my 5 iron and played it safe trickling up to the fairway and minimizing my potential for loss. It wasn’t the sexiest thing of hitting an iron off the tee on a long Par 5 but it set myself up for success on my next couple shots and was in for a 5 (par for those non-golfers).Walking off of the green with a grin I asked myself, how is golf course management so different from our planning process at ACM?

Whether folks are initially onboarding or have been clients for a certain amount of time, the Wealth Advisors at ACM determine the client’s investment solution based on their individual need(s) – income from dividends or interest to support their existing or future lifestyle, growth from capital appreciation due to a long-term time horizon, indefinite option writing to unwind out of a concentrated position, the list goes on. As these conversations take place, one overarching theme is typically discussed and it is RISK.

What is risk? It is the degree of uncertainty or potential for a financial loss.

What is risk tolerance? It is one’s emotional bandwidth to handle financial loss and/or gain. The willingness to pursue an uncertain positive outcome which may result in loss.

What is risk capacity? The measure of how much risk you can take before it affects your financial planning needs. The ability to endure a financial loss and still be able to achieve your goal. This is usually a dollar figure. Just because someone has a high-risk tolerance doesn’t translate to a high-risk capacity. They may not financially be able to afford the loss. In my situation, the driver initially sounded great, but penciling in an 8 on the scorecard is a humbling experience and will, without a doubt, affect my overall score. I don’t have the capacity to make an 8 on the golf course and achieve the score I desire.

How do these risk themes tie into golf and/or financial planning needs? Just because the driver is in the golf bag doesn’t translate to the need of hitting it every single hole. Again, just because you have access to the resources to invest into a 100% equity portfolio doesn’t mean you should or have to in order to achieve your financial goals. Especially if you can’t stomach the potential for a temporary loss (risk tolerance) or can financially afford a downturn such as this year’s market (risk capacity). Thoughtful questions to ask yourself – How did I react in 2000, 2008 or 2020?

After completing a baseline cash flow analysis and determining what you need from the portfolio to achieve your goals, you may able to reach your financial goals and maintain your lifestyle on a 50% equity / 50% fixed income portfolio. Putting this into context, the S&P 500 has a rough historical annualized return of 10% per year since inception.

After our baseline cash flow exercise, you may need only 2%, 4% or 6% over your life time and that does not translate to a 100% equity portfolio, only partial equity exposure. Why put yourself through the whipsawing volatility when you financially don’t need to?

Is this type of investing or playing golf the sexiest thing? No, everyone wants to hit driver off the tee box or be a part of the next GameStop phenomena but ask yourself the same thing I did on the tee box while reviewing risk and my ability to handle it – what do I need to do in the most appropriate manner to achieve my goal(s)? Hit a 5 Iron? Lay Up? Invest in a “Balanced” manner?

If you have any questions, please don’t hesitate to reach out to your ACM Wealth Advisor.

The foregoing content reflects the opinions of Advisors Capital Management, LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.

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