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Managing Investment Risks

Managing Investment Risks

Sep 2021

In my opinion, it is impossible to predict future stock market returns. Investment models can produce hypothetical returns but they can’t account for future events. So, in my opinion, investors who manage their investments based on market performance or what they perceive as opportunities for better returns have very little control over the outcome.

On the other hand, there may be market risk, interest rate risk, inflation risk and taxation risk. If your investment portfolio is not vulnerable to market risk it may be vulnerable to interest rate or inflation risk. In my opinion, over the long term, taxes may impede returns and portfolio performance. If it were possible to control the risks to your portfolio, then you could try to improve the long-term performance of your investments.

Understanding all Risks

Some investors understand the concept of risk and reward. The risk of loss associated with the stock market is called “market risk”.

In my opinion, the investors who were rattled from the steep declines in the market during the 2008 crash, and more recently in the August 2011 plunge, may have decided they have little tolerance left for market risk, and some of them may have moved their money to “less risky” investments. The problem for these investors is they have now left their portfolio vulnerable to other adverse risks. Effectively managing all of your risks entails allocating your investments along a mix of assets that can act as counter-weights to the various types of risk. * Inflation Risk There is going to be inflation. When there hasn’t been inflation, there could have been deflation or stagflation, which some would consider to more dangerous conditions for investments. When investors shift their assets to low yielding or fixed yield investments to avoid market risk, they may be exposing them to inflation risk.

Interest Rate Risk

We also know that interest rates may rise; and they could fall. Unlike changes in the direction of the stock market, changes in interest rates could come with some forewarning. For instance, when the economy slows down as it has these last few years, the Federal Reserve may lower interest rates to try to stimulate economic activity. Conversely, when the economy begins to overheat, the Feds may increase rates to try to contain inflation. Generally, when interest rates rise, the prices of debt securities decrease, and in a declining interest rate environment their prices will increase.

People who stash their money in fixed yield vehicles could also be vulnerable to interest rate changes.

Taxation Risk

At one time or another, the IRS will collect its share of your investment earnings. But, as imposing as the tax code is, it may allow investors to use means to minimize taxes. Deferring taxes, which can be done using qualified retirement plans and annuities, enables your earnings to compound unimpeded by taxes so they can accumulate more quickly; however, there is usually a tax consequence when you eventually access those funds. Understanding investment taxation, such as capital gains, loss carry forward, investment income, etc., may affect the longterm growth of your assets.

In my opinion, an effective way to manage and potentially minimize investment risks is through the broad diversification of assets under a long-term investment strategy. Investors should consider their long-term objectives and overall tolerance for risk when selecting investments.

* Diversification does not necessarily produce results.

Tags: risk management, investment risks

Securities may be offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment Advisory Services may be offered through NFP Retirement, Inc. Kestra IS is not affiliated with NFP Retirement Inc., a subsidiary of NFP.

This material was created to provide accurate and reliable information on the subjects covered but should not be regarded as a complete analysis of these subjects. It is not intended to provide specific legal, tax or other professional advice. The services of an appropriate professional should be sought regarding your individual situation.

NFP retirement, Kestra IS and Kestra AS do not provide tax or legal advice. For informational purposes only. Please consult with your tax or legal advisor regarding your personal situation.

NFPR-2019-88 ACR#324839 09/19

Understanding Investment Risk

Understanding Investment Risk

Sep 2021

All investors – be they conservative, moderate or aggressive – need to understand that the level of returns they expect to generate is directly related to the amount of risk they are willing to assume – the higher the return, the higher the amount of risk one needs to take. It probably doesn’t dawn on most people that, regardless of where you put your money, you assume some element of risk. For instance, if you focus solely on keeping your money safe from the possibility of loss, you risk not accumulating enough money to meet your goal. In this case, trying to avoid “market risk” increases your exposure to other types of risk, such as “inflation risk” or “longevity risk.”

Essentially, you need risk in order to generate the level of returns you will need to achieve financial independence. However, risks can be managed far more effectively than investment performance. You can’t predict the direction of the financial markets, or which mutual fund will outperform the others; however, you can manage risk and even have it work for you through proper asset allocation and portfolio diversification. While there is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio, by including a mix of assets and securities that act as counterweights to one another, a risk aware portfolio can potentially help returns wherever they might occur while reducing overall portfolio volatility.

Understanding the different types of risks and how they can individually and collectively impact your long-term investment performance is crucial to constructing a well-conceived portfolio that seeks to maximize your returns while reducing your overall risk.

Different Types of Investment Risk

Market Risk: The risk that most people associate with investing is market risk, the possibility of losing money due to the price fluctuations of the markets. Because it is difficult to know which way prices will move, investors can lose money if the market moves against them. However, losses are only realized if the investment is actually sold.

Inflation Risk: Many risk adverse investors and savers prefer the safety of savings accounts, CDs and government bonds. The risk they face is that the growth of their secured savings doesn’t keep pace with the rate of inflation which will, in effect, reduce the value of their money in the future.

Interest Rate Risk: The prices of interest-bearing securities, such as government and corporate bonds fluctuate in response to the movement of interest rates. As interest rates rise, the prices of these securities will decline. So, it is still possible to lose money. If the bonds are held to maturity, which can be as long as 20 or 30 years, the investor receives the full-face value of the bond.

Taxation Risk: With the possible exception of some tax-exempt bonds, all investments will trigger a tax consequence, either as a result of income earned or capital gains realized from the sale of an investment. Over a long period of time, taxes can adversely impact the return on investment. Additionally, tax laws do change, so if an investment was based on its tax treatment, it could change at some point in the future.

Liquidity Risk: Investors who are concerned with having immediate access to their money need to be aware of liquidity risk. The safest of investments, such as CDs, have some liquidity risk because if it is redeemed too early the investor could lose a part of his principal to early redemption fees. And, even though stocks and bonds can generally be liquidated at any time, investors may be reluctant to do so if they are in a loss position.

When investing, all possible risks should be evaluated against your overall tolerance for risk. The most effective way to manage risk is to invest with your specific goals in mind. Also, having a long-term investment horizon may allow your investments to work through the inevitable down and up cycles of any market.

Tags: risk management, risk, investments

Investment Planning for an Uncertain World

Investment Planning for an Uncertain World

Sep 2021

Chances are good that if you turn on the prime-time news on any given day or pull up your favorite newspaper on your iPad one of the top stories will relate to emerging risks around the world. Whether it’s strife in the Middle East, tensions with Russia, or the ever-shifting balance of power between global powers, this much seems obvious: we live in a time of both unprecedented global complexity and the technological capability to watch events unfold in real time.

Investing in a Time of Geopolitical Risk

When large investment houses start talking about geopolitical risk it’s probably a good idea to take note. Some money manager may not spend time discussing the possibility that foreign policies between countries could lead to destabilizing situations, but at the end of 2014 the chair of RIT Capital Partners (a $3.5 billion fund) issued a statement that geopolitical risk was “…as dangerous as any time we have faced since World War II…”.1

Whether such a dire warning sounds overly pessimistic or not isn’t necessarily the point. What’s important is that it reveals that large money managers are starting to pay a great deal of attention to global risk.

But how to address these risks? Historically, moving 100% into cash or government bonds hasn’t been the best way to achieve growth throughout that last 100 years or so, a period of time that has seen more than its fair share of global instability. Without moving into purely defensive investments and making overly-conservative plans how can you plan for tomorrow while being mindful of risks today?

Managing Risk - and Reward - for Potential Long-Term Success

It’s often said that without risk there is no reward, and when it comes to financial planning this maxim is particularly true. For those trying to achieve long term goals, such as retirement or estate planning, it’s often times risky to try and avoid all risk.

Being overly risk-averse toward stocks can result in low returns that hardly keep up with inflation, which may in turn increase the risk of running out of money before you die or failing to fully fund an estate. For some investors cash and bonds alone don’t offer the inflation-beating returns needed to replace an income or provide a legacy to the next generation.

Fortunately, a smart financial plan, built in a way that takes into account global risks but still seeks long term growth, can help avoid these overly-cautious decision biases.

Is Your Plan Risk – and Reward – Aware?

With all the uncertainty in the news now is a great time to evaluate your financial plan to see if its managing risks in a smart way.

Does your plan:

  • Ignore the relationship between reward (investments) and risk management (insurance), or does it address both investments and insurance in a comprehensive way?
  • Diversify investments and insurance to provide multiple sources of return and income?
  • React to the latest headlines or take emotion out of the decision-making process?
  • Rely too much on one company or country? (Note: If your pension, 401k, and life insurance are all provided by your employer or heavily invested in one country this can be a big risk.)

The best way to be sure your plan is well prepared for the risks and rewards of the global economy is to talk with a professional planner today.

After all, wouldn’t it be nice to watch or read the news and not worry about the negative headlines because you know you’ve got the right plan – and the right planner – on your side.

Tags: risk management, investment management

What’s Your Risk Management Plan?

What’s Your Risk Management Plan?

Sep 2021

Most people couldn’t bear the financial hardships resulting from unexpected events, such as a major house fire, a car accident, a disability or the premature death of a family breadwinner, which is why one of the most important component of a sound financial plan should be your personal risk management strategy. Fully protecting your and your family’s financial future against the unexpected will help you to move forward with greater confidence in your wealth management decisions.

What exactly does it mean to “fully” protect your financial future? Of course, it involves insurance planning and the purchase of different forms of insurance. But before you overextend and become insurance poor, it would be important to carefully assess your risk exposures and develop a risk management plan that fits your particular needs. That requires a full understanding of all of the protections available to you and how to optimize their capacity to protect you.

Disability Income Protection

For most people, their most valuable asset is their ability to earn an income. Becoming disabled for a period of six months or longer could have a much greater impact than any of the other threats to your financial security, including losing your home in a fire, or a major car accident, or a premature death. Obtaining the best possible disability income protection plan should be your top risk management priority. Because your risk of disability increases as you get older, disability insurance can become very expensive. The best time to consider purchasing disability coverage is when you’re young and healthy.

The most important considerations for purchasing disability insurance are:

  • Obtaining a policy that protects your occupational specialty for as long as possible
  • Insuring future income increases
  • Relying first on an individual disability insurance plan and only using a group plan as a supplement

Disability income planning has become a specialty in the insurance industry, and it would be important to work with a disability specialist with access to the top disability insurance carriers in the industry.

Property and Casualty Protection

Generally, property and casualty insurance (P&C) protects us against financial loss resulting from damage to our property as well as the liability of someone harmed. Auto insurance, homeowner’s insurance, renter’s insurance and personal liability insurance are all forms of P&C coverage. The general rule is that, if you own it, insure it. Of course, there has to be an insurable interest which an insurance company deems worth protecting.

The other consideration when it comes to P&C coverage is: Don’t skimp on your coverage to save money; rather find all ways to optimize your capacity in your insurance coverage. For example: Choose the highest possible deduction for which you are financially able to cover. Paying a $1,000 deductible for a dented bumper or covering the first $2,500 of the cost of a roof replacement won’t break you. The higher deductible levels will lower your premium costs which should be redirected towards increasing your liability limits.

Personal Liability Protection

One of the least understood forms of protection is personal liability insurance; and with its capacity to form an extensive umbrella of financial protection for a low cost, it can also be the most overlooked. Most people don’t consider it because they think they have plenty of liability coverage in their homeowners and auto insurance policies.

Most people are just a slip on a banana peel away from a major lawsuit; however, people of wealth or high-income earners, such as physicians, can actually become targets of people seeking to benefit from an accommodating court system. For a few hundred dollars a year, you can provide yourself with a million dollars of umbrella protection. As a general rule, you should have umbrella liability protection to equivalent to the value of all of your assets.

Life Insurance Protection

The purchase of a life insurance policy may never make anyone's top ten list of favorite things to do. But, when given the opportunity to consider the range of purposes it can serve, it could turn out to be the most important financial instrument you own.

  • It creates an instant estate – Life insurance creates the capital a family needs when there are sufficient assets to cover their needs.
  • It provides tax advantages – Life insurance has a host of tax properties that make it attractive as a financial instrument. The death benefit is tax free to the beneficiaries. The cash value accumulates tax free. And, under certain circumstances, you can access your cash values tax free. Certain policies, such as Universal Life allow for tax free withdrawals of principal and most cash value policies allow for policy loans which are tax free. *
  • It’s cost effective – Life Insurance is a financial instrument with potential to provide the capital needed to provide for surviving family members or to settle the costs of a large estate, or to buy out the family of a deceased business partner, as inexpensively as life insurance.

The mistake many people make is to wait too long before purchasing life insurance. As with disability income insurance, the time to buy life insurance is when you are young and healthy.

*Policy loans can become taxable should the policy lapse. Also, policy loans, if not repaid, will reduce the death benefit amount.

Loans and withdrawals reduce the policy’s cash value and death benefit and increase the chance that the policy may lapse. If the policy lapses, terminates, is surrendered or becomes a modified endowment, the loan balance at such time would generally be viewed as distributed and taxable under the general rules for distributions of policy cash values.

Life insurance policies contain exclusions, limitations, reductions of benefits, and terms for keeping them in force. Your financial professional can provide you with costs and complete details.

Tags: risk management, retirement

Managing Investment Risks

Managing Investment Risks

Sep 2021

In my opinion, it is impossible to predict future stock market returns. Investment models can produce hypothetical returns but they can’t account for future events. So, in my opinion, investors who manage their investments based on market performance or what they perceive as opportunities for better returns have very little control over the outcome.

On the other hand, there may be market risk, interest rate risk, inflation risk and taxation risk. If your investment portfolio is not vulnerable to market risk it may be vulnerable to interest rate or inflation risk. In my opinion, over the long term, taxes may impede returns and portfolio performance. If it were possible to control the risks to your portfolio, then you could try to improve the long-term performance of your investments

Understanding all Risks -Some investors understand the concept of risk and reward. The risk of loss associated with the stock market is called 'market risk'.

In my opinion, the investors who were rattled from the steep declines in the market during the 2008 crash, and more recently in the August 2011 plunge, may have decided they have little tolerance left for market risk, and some of them may have moved their money to 'less risky' investments. The problem for these investors is they have now left their portfolio vulnerable to other adverse risks. Effectively managing all of your risks entails allocating your investments along a mix of assets that can act as counter-weights to the various types of risk. *

Inflation RiskThere is going to be inflation. When there hasn’t been inflation, there could have been deflation or stagflation, which some would consider to more dangerous conditions for investments. When investors shift their assets to low yielding or fixed yield investments to avoid market risk, they may be exposing them to inflation risk.

Interest Rate Risk -We also know that interest rates may rise; and they could fall. Unlike changes in the direction of the stock market, changes in interest rates could come with some forewarning. For instance, when the economy slows down as it has these last few years, the Federal Reserve may lower interest rates to try to stimulate economic activity. Conversely, when the economy begins to overheat, the Feds may increase rates to try to contain inflation. Generally, when interest rates rise, the prices of debt securities decrease, and in a declining interest rate environment their prices will increase.

People who stash their money in fixed yield vehicles could also be vulnerable to interest rate changes.

Taxation Risk -At one time or another, the IRS will collect its share of your investment earnings. But, as imposing as the tax code is, it may allow investors to use means to minimize taxes. Deferring taxes, which can be done using qualified retirement plans and annuities, enables your earnings to compound unimpeded by taxes so they can accumulate more quickly; however, there is usually a tax consequence when you eventually access those funds. Understanding investment taxation, such as capital gains, loss carry forward, investment income, etc., may affect the long-term growth of your assets.

In my opinion, an effective way to manage and potentially minimize investment risks is through the broad diversification of assets under a long-term investment strategy. Investors should consider their long-term objectives and overall tolerance for risk when selecting investments.

* Diversification does not necessarily produce results.

Tags: investment risk, risk management, investments


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