HSC’s Standard of Care: Asset Allocation Strategy
Written by Justin Victor
There are five components that make up our philosophy of strategic asset allocation, i.e., the appropriate mix of equity (stock) funds and fixed income (bond) funds in your portfolio. They include your risk tolerance, time horizon, spending, legal form and uniqueness. We use MoneyGuideProTM to analyze each component before recommending an appropriate mix of stock and bond funds. Furthermore, we manage your portfolio individually and with diligence according to our standard of care and schedule. We are not day traders and we do not make decisions on the fly. We adhere to a system that should maximize your risk-adjusted return and optimize your wealth.
- Risk Tolerance: We measure your risk tolerance in terms of your capacity and willingness to accept the inevitable ups and downs that your portfolio will experience (e., the volatility of your portfolio) over your lifetime. Capacity is a quantitative measure and willingness is a qualitative measure. We use MoneyGuideProTM and its probability simulation feature to determine a required rate of return and its attendant volatility that you must accept to accomplish your goals, including ensuring your resources will be sufficient to meet your needs in retirement and throughout your lifetime. In addition to this quantitative measure, we want to qualitatively measure your willingness to accept that required rate of return and the volatility associated with that return. Your willingness is based on your emotional response to the ups and downs—especially the downs—that your portfolio will experience over your lifetime. There are numerous risk tolerance questionnaires that attempt to qualitatively assess how you feel about volatility. Many types of volatility tolerance questionnaires are flawed in that they assess your emotional response only and do not take into account any quantitative measures. Interestingly, your capacity to accept a certain return and its volatility may be out of sync with your emotional response to the inevitable downs that your portfolio will experience over your lifetime. As we educate you on our investment process and serve you faithfully, we hope to serve as your “emotional circuit breaker” and temper the negative emotional response you feel during the inevitable downs that your portfolio will experience over your lifetime.
- Time Horizon: How much time does your portfolio have before your next liquidity event? If you are in the accumulation phase of your life, you may not tap or pull from your portfolio until retirement, which could be over 20 years away. Obviously, you will be investing for a long time. Conversely, if you are retired, you may need to take a small portion from your portfolio every year, and your asset allocation could be impacted.
- Spending and Liquidity Needs: How much can you save? How much do you need to withdraw? Rather than asking when you will add to or withdraw from your portfolio, our process asks how much will you add or withdraw. Before retirement, steady contributions are so important and allow portfolios to expand. Especially at the beginning, consistent contributions are key to growth. Eventually, you reach a point where you need to strategically identify how you are going to spend the money that you have invested. This applies when you begin to actively withdrawing from your portfolio. How much you take out is of great importance and is assessed when we model your capacity and willingness to accept the inevitable downs that your portfolio will experience over your lifetime. We coach you to adjust withdrawals when the portfolio could not sustain draws over a long time frame.
- Legal Form: We must consider if any rules apply to your situation that require withdrawals. For example, some of you have trusts requiring a certain distribution percentage annually. Another example is the tax law that requires you to withdraw your Required Minimum Distribution from your IRA(s) While you may not need an RMD to sustain your lifestyle, you still are required by law to withdraw it each year.
- Uniqueness: You may have a unique situation that negates a few of the other components of asset allocation. A classic example of this is Warren Buffet, who has stated that his asset allocation is 90% equities and 10% bonds. For someone his age, this is a highly aggressive portfolio. However, considering the rarity of his situation and that he is worth literally billions of dollars, he can certainly afford to have an aggressive portfolio because he and his wife will never use all this money in their lifetime. Each of you is unique; we provide guidance and expertise to discover what mix of stock funds and bond funds optimizes our management of your plan.
Our process systematically incorporates all factors that could affect your asset mix in a manner that addresses your unique goals. It is important to remember that there is no perfect system but, by following the principles of sound investing and by being aware of your personal situation, we provide a standard of care in determining your asset allocation that should maximize your risk-adjusted return and optimize your wealth.
Contact HSC Wealth Advisors to see how we can help you determine the appropriate investment strategy for you.
