Facing meager returns, is increased risk the answer?

The following is excerpted from a Q&A with the research team at Litman Gregory, and which appears in the firms.No-Load Fund Analyst newsletter.

Q: What is your portfolio strategy looking forward in the face of meager expected returns for so many asset classes? Why not take more risk to achieve clients’ financial goals?

We covered the first question about our portfolio strategy in our discussions of our current positioning and how we view the risks and returns across asset classes. Certainly we continue to search for attractive investment opportunities, both in the alternative strategies space as well as within more traditional asset classes when we think we can improve our portfolios’ returns while adhering to our risk-management objectives.

But, there is no getting around the fact that in our assessment we are facing some major investment headwinds right now in the form of exceptionally low interest rates, unattractive equity valuations, unprecedented macro risks, and just the overall high degree of uncertainty as to how things will play out over the next few years.

With regard to the second question, taking on more risk in order to try to achieve a higher long-term return is certainly an option. This probably goes without saying, but if a client increases their portfolio-risk exposure and a negative scenario does play out and the client is actually unable psychologically or financially to withstand the increased downside risk and volatility, and they get scared into selling after a large market decline, then you will have likely done your client more harm than good in trying to help them achieve their financial goals.

So, of course it is critical to work with each client to really understand their risk tolerance as well as their financial goals, and to be clear and upfront with them if the two are incompatible. Once their risk tolerance is confirmed, then work out a plan that makes sense and has a reasonable likelihood of being achieved, taking into account the client’s risk tolerance and time horizon, as well as the current investment environment. That might mean, of course, that the client has to alter their financial goals or change their current spending and saving habits in order to achieve their goals in what is likely to be a multiyear low-return environment for most investments.

As we mentioned earlier, we think this is a time where patience and discipline, and an increased focus on risk assessment and risk management, are more important than ever. In general, we don’t view this as a time to be taking on more risk. Of course, this will vary depending on each individual’s circumstances.

Related Topics: Asset Allocation, Risk Management