Consider using collared strategy if concerned about investment risks
Dear Money Lady,
I am a single, retired women with a good stock portfolio but I worry about what I am invested in. My advisor says that everything is fine and that the investments are put in securities that fit my risk — but I don’t think so. What should I do?
— Shelly Shelly — you must be comfortable with your investment choices! Your advisor is there to help you, not take over!
Often when people talk to their financial advisors, the advisors often refer to your asset allocation as the primary driver of long-term portfolio performance, but what investment philosophy are they really following? Do generic risk questionnaires really help advisors create an investment strategy that meets your specific future goals? Maybe.
Experienced investors understand the risk-return trade-off of the market and are more comfortable with market volatility. These investors are constantly looking for opportunities to profit over long-term time horizons. It is true that one must accept
a higher degree of risk to earn a higher return, but not all investors can afford future losses. Our ability to bear risk has a tendency to decrease as we age, and often those investors who believe they have a high tolerance for market risk suddenly change their minds when the market turns against them.
Shelly, if you are not a knowledgeable investor, and are relying solely on the decisions of your advisor, you should make sure you have communicated your risk tolerance and are invested correctly. Often, clients fill out risk questionnaires with their advisors the way they would like to behave when faced with risk, while how they really
behave may be completely different.
Let’s look at the basics of the two main asset classes to choose from and what key influences they each have that your advisor should be aware of when formulating your portfolio: equities or fixed income — Canadian, U.S.A., international, emerging markets, and sectors.
The key influencers for equities are the current and future economic outlook, policy changes, current business cycle, market valuations, and the overall investment sentiment.
The key influencers for fixed income investments would be the same as equities but also include the duration, credit, and yield curve of the investment.
If you are purchasing securities in foreign currency, your advisor will have to consider the foreign economy and policy as well as the current rates and inflation.
Make sure you understand each investment product you have chosen with your advisor and are aware of the potential risks as well as the potential future rewards. Often, a “collar strategy” is a better approach especially for those nearing or now in retirement. This is a proactive strategy that includes giving up some of your upside return in exchange for downside protection.
With this method, you would split your portfolio
into three main components. One would be for lower volatility securities, which still have some future growth potential (for example, a lowvolatility equity ETF). The second portion would be for securities that have more stable and smoother returns and dividends (for example, a mix of blue-chip dividend SMAS); and then the third portion would be a fixed income fund that concentrates mainly on capital protection (for example, a fixed income SMA with a floor value return).
Why not discuss a “collared strategy” with your advisor? I have always recommended this approach to clients that are wanting to reduce volatility and require capital protection. It still gives you the traditional diversification that you need but provides a more consistent return and hedges against significant market declines.
Good luck and best wishes, ATML - Christine Ibbotson