Risk Aversion Some clients are risk averse while others are risk seekers. Most are unaware of their own risk tolerance and we find it changes depending on market conditions — risk averse in down markets and risk seeking in up markets. One of our responsibilities is to determine a client’s risk tolerance. We are also risk averse when creating asset allocation models and selecting investment vehicles. The only acceptable risks are those that are likely to generate adequate returns.
Diversification Spreading assets across different kinds of investments to reduce risk and potentially increase returns is perhaps the most important principle when investing. We diversify by sector, asset class, and correlation.
Time Horizon Before assets are invested, it is crucial to understand the time horizon. Obviously money that is needed in three months should be invested much differently than money that will be needed in ten years.
Time In, Not Timing. It is virtually impossible to consistently predict whether the market will move up or down, and the risk of trying outweighs any possible rewards and are unlikely to increase long-term performance. Such practices are therefore avoided.
Strategic Asset Allocation The portfolio as a whole is more important than individual funds. The appropriate allocation of capital among different asset classes will have far more influence on long-term results of the portfolio than the selection of individual funds. Over 90 percent of investment returns are determined by how investors allocate their assets versus security selection, market timing and other factors.* Source: Brinson, Singer, and Beebower, Financial Analyst Journal, 1991
Modern Portfolio Theory As recognized by the 1990 Nobel Prize, Modern Portfolio Theory is the primary influence driving the portfolio structure. For every risk level, there exists an optimal combination of asset classes that will maximize returns. A diverse set of asset classes minimizes risk. The asset class proportions determine the long-term risk and return characteristics of the portfolio as a whole. Portfolio risk can be decreased by increasing diversification of the portfolio and by lowering the correlation of market behavior among the asset classes selected. (Correlation is the statistical term for the extent to which two asset classes move in tandem or opposition to one another.)