Risk management and robust portfolios

Monday, May 20 2019 by
Risk management and robust portfolios

We’ve all seen the warnings. Past performance is not a reliable indicator of future returns. The value of an investment can go down as well as up. You might not get back the amount you invested.

Risk is a part of the game in investing, but it’s hard to see and easy to forget about. That is partly why many fund managers often construct an Investment Policy Statement (IPS) for their clients. These statements are intended to spell out a client’s investment objectives and constraints. Sounds basic - and it is - but how many of us actually do anything like this ourselves?

Applying aspects of the IPS to our own situations might allow us to better articulate and justify our investing strategies. The first step would be to describe your situation in a brief client description. This might include your age, employment status, and any dependents. 

Once that is sketched out, it is time to write down in greater detail your investment objectives and constraints.


Two big constraints on investment strategy are liquidity and time horizon.

Say a meteorite crashes through the conservatory roof one night and you have to shell out for repairs. If this kind of eventuality hasn’t been factored into your strategy and you have invested in illiquid micro caps, you might then have to sell stock at a distressed price in order to restore your mess of a house. Unfortunately, you are now a victim of liquidity risk (as well as an errant asteroid).

This kind of risk is better off avoided by considering your potential liquidity requirements and comparing them against the size of your portfolio, the amount of income it generates, and how much you earn. Liquidity risk is why some people keep a rainy day fund in their bank accounts or a minimum amount of their portfolios in cash and other liquid assets.

Time horizon is also an important consideration. A 30-year-old investor at the start of his or her career can probably afford to take more risk than somebody with the same amount of money who is about to retire. It is worth considering how your time horizon modifies your ability to take risk. The resulting conclusion might also affect your asset allocation. A shorter time horizon and lower risk tolerance might mean a more diversified equity portfolio and a greater weighting in assets like highly…

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As per our Terms of Use, Stockopedia is a financial news & data site, discussion forum and content aggregator. Our site should be used for educational & informational purposes only. We do not provide investment advice, recommendations or views as to whether an investment or strategy is suited to the investment needs of a specific individual. You should make your own decisions and seek independent professional advice before doing so. The author may own shares in any companies discussed, all opinions are his/her own & are general/impersonal. Remember: Shares can go down as well as up. Past performance is not a guide to future performance & investors may not get back the amount invested.

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3 Comments on this Article show/hide all

underscored 20th May 1 of 3

Don’t forget risk is not just volatility, though that can be risky, it is running out of money

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wilkonz 21st May 2 of 3

Many thanks Jack. Diversification seems to be the best way of protecting one's portfolio. I've been examining some well diversified portfolios recently and the overall message seems to be:

Equities - maybe 40-60% including USA and Emerging markets
Bonds - 20-40%
Gold - 5%
Property (REITs) - 5-10%
Cash - 5-15%

Almost without exception the portfolios are made up from index linked ETFs on the ground that they are cheap -small spreads and low running costs - and statistically outperform actively managed funds. Ideally they are rebalanced at regular intervals to keep the ratios constant. And people about to retire are advised to reduce the proportion of equities to 20-40% to reduce the impact of dips in the market.

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Jack Brumby 21st May 3 of 3

In reply to post #477401

I agree, volatility risk is probably just one type of risk. Unlike other types it is easily quantifiable - maybe that's why volatility measures are so popular?

I think it's Howard Marks that says something like 'financial risk is the possibility of a permanent loss in capital', which seems as good a definition as I've heard...

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