In today’s unpredictable financial markets, managing risk is more critical than ever—especially for financial advisors working with high-net-worth (HNW) clients. Portfolio risk management isn’t just about avoiding losses; it’s about strategically positioning portfolios to protect wealth while capitalizing on opportunities.
Whether your clients are concerned about shifting market conditions or evolving risk tolerances, there are several strategies you can use to help reduce risk and provide financial confidence.
Buy and Hold: One Approach to Risk Reduction in a Declining Market
When your client’s primary goal is reducing risk, a buy-and-hold strategy could be useful for some clients . For example, in a balanced 60/40 stock/bond allocation, the equity portion of the portfolio would likely decrease relative to the fixed income portion during periods of market decline, effectively shifting the portfolio toward a more conservative risk profile like 50/50 or 40/60.
The simplicity and effectiveness of buy-and-hold strategies make them a strong contender in both bull and bear markets.
When Can Buy and Hold Add Value?
Constant Mix: A Dynamic Strategy for Volatile Markets
For clients who are more comfortable with a hands-on approach, the constant mix strategy offers an active method to manage risk. This strategy involves rebalancing portfolios by increasing equity exposure during market lows and selling equities during highs—essentially, buying low and selling high.
By maintaining a consistent risk profile through regular rebalancing, you can help clients navigate the ups and downs of volatile markets effectively.
When Can the Constant Mix Approach Add Value?
Constant Proportion Portfolio Insurance (CPPI): Protecting the Downside with a Floor
CPPI is a more advanced strategy that combines elements of insurance with dynamic asset allocation. This method involves setting a floor value for the portfolio and adjusting the equity allocation based on a multiplier of the difference between the portfolio’s value and the floor.
For example, your client decides to allocate $100 to a portfolio and denotes $75 as the floor. The allocation to the risky asset at inception is determined by the multiplier times the difference in the portfolio value and the floor. Here, let’s assume a multiplier of 2:
• The allocation to equities would be 2 × (portfolio value – floor) or $50 at inception.
• If markets decline over the next year and the portfolio level reaches $95, your client would rebalance the equity portion to $40 (2 × [$95 – $75]).
If fear grips the market and the portfolio drops to the floor, you would allocate all proceeds to the lower-risk asset. Consequently, the stock allocation will be dynamic and will increase (decrease) along with the appreciation (depreciation) in stocks at a faster pace than if you had used a simple buy-and-hold strategy. The main difference between the two strategies is the multiplier and the incorporation of a floor value, also called the insurance value.
When Can CPPI Add Value?
Guiding Clients Through Turbulent Markets
While it’s natural for investors to feel the urge to react to perceived dangers like a potential recession, adhering to a well-thought-out investment strategy often yields better results over time. Your guidance becomes critical in helping clients understand the importance of maintaining a steady hand and managing risk effectively.
By walking clients through various options and the reasoning behind your recommendations, you can demonstrate the value of staying the course. Implementing portfolio risk management strategies such as buy-and-hold, constant mix, and CPPI not only helps preserve wealth but also positions clients to achieve their long-term financial goals.
This material is intended for informational and educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Investors should contact their financial professional for more information specific to their situation.
All examples are hypothetical and are for illustrative purposes only. No specific investments were used. Actual results will vary.
Asset allocation programs do not assure a profit or protect against loss in declining markets. No program can guarantee that any objective or goal will be achieved. Investments are subject to risk, including the loss of principal. Because investment return and principal value fluctuate, shares may be worth more or less than their original value. Some investments are not suitable for all investors, and there is no guarantee that any investing goal will be met. Past performance is no guarantee of future results.
This post originally appeared on Insights, a blog authored by subject-matter experts at Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser.
