Risk Demand - What it means in your plan
Risk Demand (or Risk Need)
Everyone wants to make money in securities. The only way to do that is to take buy equities (or common stock) to increase the risk. The risk, or uncertainty of the future price, is the exact mechanism that creates value, as the current price reflects the chance that it is wrong. While Solitude employs methods to control risk, eliminating it is not desired since it eliminates all of the potential for gains. Those gains are what allow you to overpower inflation to fund your goals.
So how much risk does one need? While that could fill a book, the short answer for Solitude is “the amount required to get the client’s goals funded on time”. As the most basic goal we fund is retirement, it is our experience that a simple answer exists. We believe most clients can fund retirement as long as they have “10 times their lifestyle” saved by age 65, provided we use Social Security and common equities as part of the plan.
We arrive at this number in the following manner: Take your Net Worth (in dollars) divided by your current expenses (dollars per year) to yield an answer in “years of stored lifestyle”. Since that number scales directly with how fast you are spending, it helps me answer “Are you prepared to retire” whether you spend $50,000 per year or several times more. Our experience shows that savings of $1M for a client with a lifestyle of about $100,000 SHOULD be able to retire at age 65, provided that their spending scales with inflation, using at most average risk from that point forward. If that same person has $100,000 saved up at ANY age, we can now calculate how fast their nest egg must grow to achieve that final target by age 65. I won’t bore you with the math, but we won’t take clients whose goals require growth rates outside of about 5% to 10%. The market will not allow rates faster than that without taking risk beyond what we would be comfortable with using YOUR money.
Returns in this range will double a portfolio every 7 to 15 years, giving us an idea of how much risk to take for you (meaning the amount of stock to buy for you). If you need to double a portfolio in 15 years - we can use low risk, perhaps 50% equities. 10 years? Average risk, more like 60 to 70%. 7 years? Above average risk, and as much as 95% equities.. This determines the level of risk I set in your portfolio. While we test for Risk TOLERANCE, that is just to ensure that yours is sufficient to support the actual Risk DEMAND (or need). In other words, that you don’t get scared out of your plan, since the volatility goes up directly with the risk as more securities are added to increase the return. Going faster when you don't need to does not make sense, will scare you, and will tend to get us fired - which is avoided by explaining all of this in the first place. We need you to understand that rapid growth is not the goal - your retirement, on time, IS the goal.
You have (or will) see this concept in plain language on your Investment Policy Statement to ensure we both understand YOUR level of NEED and RETURN. We are repapering the IPS for those of you who don't have a statement of risk demand included. If yours IPS does not have a statement of Risk Demand on it, expect to see an electronic document to correct the issue shortly.