Securing Your Financial Future: Advanced Risk Management is Central
By Jerry Miccolis, Chief Investment Officer, Principal and Senior Financial Advisor
When our parents talked about retirement, they spoke of a three-legged stool — a balance of their pensions, Social Security, and personal savings. The first two — then the strongest, most dependable legs — were supported by employers and the federal government, respectively. For our generation, today, those two legs are extremely wobbly, if not broken. Over the last few decades, many employers have discontinued offering “defined benefit” plans (pensions) altogether, and have turned to “defined contribution” plans, chiefly 401(k) Plans, instead. Social Security, once considered a rock-solid source of retirement income, is by all accounts not sustainable in its current form — and it is unclear what concessions in benefits will need to be made to restore the program’s viability. As a result of these changes, the onus — and all of the risk — of funding your retirement has shifted to you, the individual investor. This entails quite a bit of pressure on many people, most of whom may not have the same tools as those pension plan administrators who were minding your parents’ investments. Making the right decisions, and sticking with them, to fund the retirement lifestyle you want is no easy feat.
Two of the Biggest Risks to Your Financial Security? Inflation and Emotion
Although markets have recovered nicely since the crash of late 2008, subsequent world events have made some investors reluctant to put a significant amount of money back into the markets for fear of another precipitous drop in the value of their portfolios — perhaps one they may not be able to recover from during their retirement. But your personal savings must work hard and grow significantly to stay ahead of your biggest economic risk. That risk, over the rest of your life, is not short-term market fluctuation — it’s not natural disasters, nuclear accidents, or Mideast uprisings either — it’s inflation. Even if you’re already retired, you may be surprised to know that your living expenses could easily double over your remaining life span, without any change in your lifestyle. If a good part of your savings is at the bank sitting in a money market fund, or invested in Treasury bonds, or stuffed under a mattress, it won’t help you beat the insidious risk of inflation; your nest egg will only slowly and steadily lose its purchasing power, until it’s too late. To guard against inflation’s steady erosive power, most people need to invest in the markets for the long term. In order to do this, they must ride out the short-term ups and downs of the market, while keeping their emotions in check. There is a reason that, while stock index funds earn about 10% annually over the long term, the average individual investor in those funds earns less than half that return. That reason is emotion. Exiting and entering the markets at precisely the wrong times is, unfortunately, human nature. The way we manage the twin risks of inflation and emotion for you is by starting with an investment strategy based on your unique set of financial circumstances (time horizon, long-term objectives, risk tolerance, cash flow needs, tax situation, investment constraints, etc.). That investment strategy is executed by means of a scientifically-derived asset allocation, informed by our proprietary modeling and analysis. Then, to make sure that your assets are working their hardest for you, we use rigorous, rules-based, opportunistic rebalancing to keep your portfolio true to its target asset allocation and help garner extra return with no increase in risk.
But Risk Management Needs to Go Further
For many years, the risk management methodologies embedded in scientific asset allocation and rebalancing were enough. They were enough, for example, to get our clients through the severe three-year bear market of 2000-2002 with limited damage. But the market crash of late 2008, when virtually all asset classes declined suddenly at once, was another matter. It was clear that the risk management techniques we had been continually refining needed to take a quantum leap forward. The first enhancement we added was an extra layer of protection — catastrophe insurance, if you will, that kicks in automatically only when needed, i.e., in the event of a precipitous market decline that confounds the standard defenses of diversification. In other words, a safety net that would result in market appreciation during severe market downturns without resulting in a drag on the portfolio during vastly more likely market conditions. That protection, which had its first anniversary earlier this year, is the subject of the following article and our most recent Client Bulletin. Although we are very pleased with the performance of our safety net thus far, we have much more in mind — and in the works — to further protect your portfolio.
And We Are Well-Equipped to Get You There
Before coming to Brinton Eaton, I had the benefit of over 30 years’ experience in the corporate risk management and actuarial fields. During that time, I was fortunate enough to be on the forefront of introducing Enterprise Risk Management (ERM) to industry, where it has since established a firm foothold. We have been methodically applying proven elements of the ERM framework to our investment practice at Brinton Eaton for several years now. It has been working, and we are ramping up those efforts. We will be reporting more on those developments in the months ahead. We strongly believe that risk management is at the core of successful investment management. Now more than ever. Our focus on bringing world-class risk management to bear on your behalf has guided, and will continue to influence, the important decisions we make regarding our investment in tools, equipment, analysis, staffing, education, and training. Brinton Eaton is emerging as an industry leader in applying advanced risk management to investing, and you will be the beneficiary. Stay tuned.
As always, please let us know if you have any questions along the way.
