05 Sep 2014 Running and Risk
There is such a proliferation of 13.1 and 26.2 stickers on the road in Raleigh these days that some of us without a half or full marathon under our belts have struck back with 0.0 stickers.
But for today we are all runners. We are registered for a half marathon in three months and have hired a coach to help us train. Our goal for the race is a simple one: beat two hours.
During our first meeting, the coach presents us with three training programs. Program A is intensely rigorous and will prepare us to finish the race in as little as 1:20, but has a much higher chance of causing injury during the training period. Program B is difficult, but doable, and will set us up to finish just below the 2 hour mark. Program C is the easiest, and will enable us to finish in just under 3 hours.
The coach then hands us a form. The form, through a long series of questions, measures two things with equal weight: physical fitness and mental fortitude. Let’s say we are in good shape physically, but we hate even the thought of injury to such an extreme degree that the questionnaire suggests Program C. This enables us to coast through training, and through the race, finishing nowhere near our goal. Or let’s say we are in poor shape physically, but are willing to accept a great deal of pain such that the questionnaire suggests Program A. We acquire a herniated disk in the third week of training and have no chance of racing at all.
Much like our coach above, financial advisors typically deal with portfolio risk through the use of a questionnaire. There’s a good chance you’ve filled one out. These questionnaires are designed to measure two things: your Risk Capacity (your financial ability to support risk over time–think time horizon) and your Risk Tolerance (your mental and emotional willingness to cope with risk). But there’s a third facet of risk that they don’t measure: your Risk Requirement.
Did you notice that our running questionnaire never asked what our desired time was? If it had, our coach might have been able to help the in-shape but very timid runner strive for Program B (and a met goal), or advise the out of shape but gung ho runner that Program A would be dangerous. In the same way, those financial questionnaires don’t take into account your specific goals.
See, we accept physical pain and risk only because of what they buy us in return. The miles may enable us to run the half marathon in 1:59, and the risk may help us achieve our financial (and life) goals. Outside the context of goals, pain and risk are things to avoid.
The S&P 500 continues to flirt with all-time highs. Is your portfolio designed to take only the amount of risk necessary to achieve your life goals? Or are you set up to experience the maximum amount of risk you can tolerate?