How much can you stand to lose?

One of my favorite columnists is Jason Zweig of the Wall Street Journal.  His Saturday column, “The Intelligent Investor” strikes me as a straight forward, common sense view on the markets and investing.  His recent piece on buying stocks at record highs was particularly interesting because of the way he addressed the potential for loss.  As 2013 comes to a close and markets bounce around historical highs, the time may be right to reflect on portfolios, how they are allocated and how much loss can be sustained if markets retreat.

As investment managers and financial planners, risk is often discussed in terms of percentage loss.  I believe discussing loss in terms of a percentage falls short of trying to help clients understand risk and the potential for loss.  This shortcoming was frequently proven during the last financial crises when clients grew anxious over dollar losses that did not reconcile with the equivalent percentage loss they said they were willing to accept.

When deciding on the right mix of cash, bonds, hybrids and equities (a diversified portfolio), Mr. Zweig rightly suggests to consider risk first instead of how much portfolio growth you want to achieve.  Siting the approach of David Salem, chief investment officer at Windhorse Capital Management in Boston, Mr. Zweig goes further and encourages investors to consider the amount of money (dollars, not percentages) kept in stocks.  Of this amount, how much are you willing to lose?  Because Clearview Wealth Management believes portfolios should have a hybrid asset class (not correlated to equities or bonds) some investors might consider this asset class more like stocks than bonds and want to add this dollar amount to their stock investments.

Whether you choose to consider only your equities or combine your equities and hybrids, reflecting on how much money you have in each and how much you are willing to lose may help better define your tolerance for risk and loss.  The great recession taught most of us to think of risk more in terms of dollars.  The strength of the markets since have very likely made investors become too focused on the dollar gains and in turn, lose sight of the potential for loss.  At Clearview Wealth Management, fully diversified portfolios to mitigate volatility will always be a priority and a topic of discussion.  That dialogue includes the potential for loss and efforts to define what that means to each client.  Clients and investment managers should share that responsibility by reflecting on their equities, how much loss they are willing to incur and weaving that in to portfolio discussions with their investment advisors.