Risk matters

It’s no secret that the last few years have been economically uncertain. The markets have been volatile, and while we still work to make our clients money, we have evolved our strategy to meet the ever-changing environment. We now aim to both advance and protect our clients’ assets.

One of the most powerful aspects of our Advance and Protect strategy that is normally invisible until the market drops is the fact that the rates of return are risk adjusted.

The goal of a risk-adjusted return is to reduce risk as much as possible in achieving any level of return.

For example, two portfolios have the same 5 percent return made over the last 12 months. One is 100 percent invested in government guaranteed treasury bonds and the other is 100 percent invested in small-cap stocks. The treasury portfolio, which has very little volatility, made the same amount of money as the small-cap portfolio where there is extreme volatility. Clearly risk matters.

Two financial statistics used in our industry to measure risk are Standard Deviation and the Sharpe ratio. With Standard Deviation, the "lower" its number, the less volatile it is compared to other portfolios. With the Sharpe ratio, the "higher" its number in comparison with other portfolios, the less risk it's taking to get a given level of return. (Think low number for Standard Deviation is good and high number for Sharpe ratio is good).

Our 60 percent equity and 40 percent fixed income model in Advance and Protect strategy has the "lowest" Standard Deviation over a 3, 5 and 10 year period through 9/30/13 when compared with a 60 percent equity and 40 percent fixed income model in a Buy-and-Hold strategy. Its five year average annual standard deviation of 8.05 percent is 40 percent less volatile than the Buy-and-Hold strategy. This is impressive from a safety perspective.

Also, our Advance and Protect strategy has the "highest" Sharpe ratio for any measuring period. Its five-year average annual Sharpe ratio of 1.23 is almost three times as much the .42 for the Buy-and-Hold strategy. This is even more impressive from a safety perspective.

The number one goal of a risk adjusted portfolio is not to make the most money, but to keep the money safer. A general principle of investing is that the less risk an investment has, the less return you can expect to earn. However, over the 3, 5 and 10 year period, our Advance and Protect model outperformed a similar model in a Buy-and-Hold strategy, while taking much less risk.