Risk Capacity
Stipulations
- Risk tolerance scales are worthless. Risk is a game by Parker Brothers. Inclination predicted scorecards (if they had them) would have a lower rating for accuracy than Anthony Fauci (with excuses and denials optional).
- Sequence of rate of return risk has been addressed in other writing
- Most confuse volatility as risk (which is why qualified by the question of Enough as determined per each goal) at least 2 years of cash – money markets etc – as there seems to be an inverse relationship between high client risk bravado relative to investable assets when things are ‘good’ and greater fear and anxiety when things go down. Thus, the idea is to minimize whip sawing by the cushion by ‘this is different, this time.’
Risk is not making one’s goals – in particular the clientele realizable goal and their determined payoffs. Risk capacity is the willingness to readjust one’s personal financial goals – in non euphemistic terms – get less – and trade off.
More often than not, usually Monte Carlo analysis people and especially planners (incentivized by getting compensation by assets under management – the more assets under management the greater the compensation) want 95% - 100% probability. The result: more asset under management for the planner (for sure), a higher probability of an larger estate (assets for members of the lucky sperm and ovarian club), and usually less spending (out of fear of outliving their money) by the clients.
There are no solutions only tradeoffs
Professor Thomas Sowell
Other than if the assets on a net worth/balance sheet were inherited, the net worth is a result of human capital (income less consumption and taxes) reinvested for investment capital. No where on personal balance sheets is the recognition of the human capital asset of adaptability and resourcefulness. (Note for those reading and saying right now – but I was younger then, but, but, but).
We given little or no value to our resourcefulness to adapt and therefore (without the question of More vs Enough aside) 100% is sought at the expense of denying (even if one has more than Enough).
So
the question is risk capacity – is one on Monte Carlo will to take an 80% probability
of success – a 20% adjustment if necessary? What is the tradeoff?
Now
when I was in practice – I required spending plans (a nice word for budgets)
not just presently, but projected upon disability, slowing down, retirement and
for the spouse if the client predeceased. Furthermore, the categories were
broken down into:
- Fixed monthly
- Flexible monthly
- Irregular Expenditures
- Estimated taxes
Irregular
expenses (may be fixed – i.e. homeowners
insurance, etc) but otherwise offer the most flexibility to reduce. Flexible
monthly offer some potential for reduction (i.e. the cable etc bill). Of
course, the degree or amount depend on the goal – if disabled, long term care,
slow down, retirement, spouse income adequacy. Furthermore, the retirement objective
should be broken down into three periods – go/go; slow go; no go. And yes,
health expenditures go up in fixed and flexible but other costs depending on
the period would go down.
By doing the budgets per objective – one can estimate the degree of flexibility –risk/adjustment capacity – to therefore determine 80%, 85%, 90% etc of what one is will to accept for adjustment to have a higher degree of spending.
