The key to both wealth creation and wealth preservation over time is to minimize the risk of permanent capital loss.
When it comes to risk and wealth preservation, a highly critical point for most investors is to think long term, when appropriate, considering a client’s investment horizon. While market volatility can be unsettling, the market tends to eventually reward sound, profitable companies. “Eventually” requires long-term thinking and the discipline to avoid overreacting, and long-term thinking can prevent investors from turning a temporary “paper” loss into a permanent loss of capital by abandoning the investment strategy and getting out of the market.
But when we talk about the idea of risk, what exactly do we mean? In simple investing terms, risk is the chance that the outcome of a decision will be different from what was calculated or expected:
- Systematic risk includes the factors relating to an investment that can’t be eliminated by diversification, such as investing solely in an index fund that mirrors the broader market’s performance.
- Unsystematic risk is particular to an asset and can be diminished or reduced through diversification. For instance, if a pharmaceutical company held in a portfolio is unable to get approval for a major new drug, then that one stock is going to be significantly affected.
There are several ways for investment managers to measure the degree of risk inherent in a particular investment, including:
- Standard deviation, which provides a measure of the volatility of the investment by calculating changes in its periodic rate of return
- Beta, the measure of a stock’s relative volatility and sensitivity to the rest of the market, which helps define its risk profile
Of course, these performance-based, quantitative assessments of specific investments are important, but in order to protect clients against the unnecessary risk of not reaching an important future goal, Atlantic Trust’s investment team analyzes multiple qualitative factors and then extrapolates that information into a forward-looking projection.
In addition, investors must always feel they’re getting the appropriate reward potential for the level of risk they’re taking. Otherwise, investments wouldn’t be made, as there would be no reason to take on additional risk if the rewards do not come to fruition over the long term. That’s why Atlantic Trust’s wealth management professionals also take the following characteristics under consideration when developing a client’s investment plan:
- Risk capacity is a financial characteristic that describes the risk a client can afford to absorb and still reach goals. Risk capacity is often determined by analyzing an investor’s individual financial circumstances.
- Risk tolerance is more of a personality characteristic and tends to be more abstract and nuanced. It’s important to remember that risk tolerance is not a number—or a constant. It’s a moving target based on our clients’ life circumstances, and it’s the advisory team’s job to advise them accordingly.
While understanding risk is central to long-term investing success, so is the risk management expertise of your wealth management team. Atlantic Trust’s relationship managers also help clients understand the factors that come into play in risk perception—how risk feels—which is unique to each client.
Of utmost importance is Atlantic Trust’s focus on preserving our client’s capital. To learn more about how we preserve client capital and manage risk, read our white paper “The Many Dimensions of Risk” or visit atlantictrust.com.
Bryan Reilly is a senior investment analyst for Atlantic Trust’s Proprietary Investment Team, responsible for researching the industrials and materials sectors. Additionally, he is a member of the Mid-Cap Growth Equity Team and the Asset Allocation Committee.