Finding your comfort zone

Manage risk to preserve and grow wealth for future generations

No matter how much effort you put into designing an estate plan, it wont help you sleep better at night unless you address the question of risk. Managing risk is critical to preserving and growing your wealth for future generations.

Until relatively recently, risk management wasnt a high priority for many families. Thats not surprising, given several years of uninterrupted economic prosperity. But that prosperity came to an end in late 2007 and early 2008, and the ensuing financial crisis was a wake-up call for many people. It drove home the fact that investment risk is a real concern that families need to define and manage.

Risk can be good

Its important to understand that managing risk doesnt mean eliminating it. Risk can be a good thing without it there would be no rewards. Too little risk and your asset growth may not keep pace with inflation, eroding your wealth over time. Too much risk, on the other hand, jeopardizes your familys financial security. The key is to determine an appropriate level of risk in light of your familys goals, time horizon and risk tolerance.

A fundamental principle of sound investing is to diversify your portfolio. By spreading your wealth over different asset classes, funds, companies, industries, sectors and geographical regions, you can reduce the risk that poor performance in one area will have a negative effect on your overall portfolio. That being said, however, the right asset allocation for you depends on how you and your beneficiaries evaluate and manage risk.

A balanced approach

One of the biggest challenges in managing risk is addressing the often conflicting needs and risk tolerances of family members. When it comes to investment risk, some may be more conservative while others may be more aggressive.

One way to balance these competing needs is to adopt a goal-driven approach. In other words, certain assets are earmarked to provide a safety net to ensure that the familys basic needs are met and are invested more conservatively. Other assets might be invested more aggressively and designated for other goals, such as long-term growth or supporting a particular lifestyle.

Some families are using scenario planning to manage risk. This approach evaluates the risks associated with various scenarios and designs an investment strategy thats flexible enough to adapt to changing circumstances and achieve long-term goals regardless of what the future brings. Scenario planning is similar to a goal-driven approach in that it may call for different investment vehicles or legal structures for different scenarios.

Assess your risk

In business management its often said that you cant manage what you cant measure, and the same is true of wealth planning: You cant manage your investment risks until you know what they are. It may not be possible to measure those risks with mathematical certainty, but simply starting a family dialogue on the subject can be a powerful planning strategy.