Let's start with a basic description and understanding of risk and how it impacts portfolio strategy. To begin, investment risk is most easily measured as volatility, or the variance of investment values over time. In general, the relationship is that the higher the level of investment volatility, the higher the level of risk. If we break all investments into broad asset classes such as cash, equities (stocks), fixed income and alternatives, we find that historically these asset classes have varying levels of volatility (risk) and return. Generally, higher levels of risk offer the potential for higher returns when measured over time. Adjusting the exposure, or allocation, of these investment asset classes allows manipulation of the portfolio strategy and risk level. In other words, a portfolio with greater allocation to riskier asset classes will tend to exhibit greater risk than one exposed to less risky asset class investments. For example, the equity asset class is historically riskier than the cash asset class. Thus, a portfolio with a heavy weighting to stocks will tend to exhibit higher volatility and risk than one heavily weighted to cash.

Now that we have defined risk and understand how portfolio strategy affects it, we can look at how risk exposure can be fine-tuned for investors. At Barron Financial, we use an investment policy statement that outlines a client's risk profile. The personalized risk profile is influenced by factors such as client goals, time horizon, and others, and sets a framework for portfolio strategy. With this framework, we can better establish, monitor and adjust risk exposure and asset class allocation. We try to find a balance of investments within the framework of the client's risk profile to help them reach their goals without being overly risky. Not surprisingly, that investment balance is specific for each client and risk profile managed.

You might wonder "How do I set my own risk profile?" I cannot answer that question here. But I can offer what I believe is the most important component of determining risk profile...time horizon. As time horizon gets longer, your ability to take and manage risk increases. For example, a 30 year old person expecting to retire at age 65 has a 35 year accumulation time horizon to retirement. With a typical business cycle of 7 to 10 years (and some argue it is getting shorter) that person will see market cycles of peaks and troughs at least several times before retirement. An aggressive, capital growth strategy that swings substantially in value may be a reasonable choice. By comparison, a 64 year old person expecting to retire at age 65 has an accumulation time horizon of just one year. There is little chance of seeing a full market cycle in that time and may suggest a less aggressive approach.

Going one step further with our examples we consider the after retirement, distribution time horizon, a.k.a. life expectancy. Currently, a person age 65 can expect to live to about age 84, or another 19 years. This in-retirement time horizon doesn't mean much to our younger investor, but for our older investor it is very important. While the accumulation time horizon is only one year, they have a 19 year distribution time horizon. We now could expect at least one full market cycle and can easily justify having some risk exposure. In a year, when that person retires, the total time horizon goes from 20 years (one plus 19) to 19 years even. Not much different. Thus, I submit to you (and to my recent client) that the risk profile and portfolio need of someone close to vs. just entering retirement is very similar.