Nate Creviston Details Risk-Averse Portfolio Construction With Investment News

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Risk-averse investors push advisers to their creative limits

Financial advisers get creative to keep conservative clients from losing ground to inflation

Mar 6, 2019 @ 4:59 pm

By Jeff Benjamin

One of the biggest challenges financial advisers face when working with clients in or near retirement is convincing them to embrace an appropriate level of investment risk, which is often where psychology must partner with reality.

When considering the extreme example of a client wanting no part of stock-market risk, most advisers suggest turning back time and saving more money.

But, considering the slim chances of the client having access to a time machine, advisers admit there are some creative ways to protect the portfolios of the most risk-averse clients — assuming those clients are willing to accept the trade-offs.

"There is no free lunch out there, but we have done this for clients in a variety of ways," said Daryl Deke, chief executive of New Market Wealth Management.

For clients who just can't stomach the idea of stock market volatility, Mr. Deke said he has helped them construct diversified portfolios of traditional bonds, master limited partnerships, business development companies and real estate investment trusts.

Think of it as combining credit and duration into a portfolio, and it's especially valuable inside a retirement account because you can be less concerned about the tax consequences," he said. "There are still risks, because there's price volatility, but you can build a portfolio where there will be less risk than you get in the stock market."

Unless clients have more money than they could possibly spend in retirement, the biggest risk is usually time. And staying ahead of inflation is difficult when abandoning the growth potential of the equity markets.

Consider, for example, that over the past 10 years through March 5, the S&P 500 Index experienced an average annualized gain of 17.06%.

Meanwhile, over the same period, the Bloomberg Barclays US Aggregate Bond Index had an average annualized return of 3.67%.

That kind of extreme performance disparity is often what gives financial advisers fits when clients insist the stock market is too risky.

"I would suggest the number one way to live on 5% of the investor's assets, without the risk of outliving those assets, is a variable annuity with a guaranteed income rider," said Tim Holsworth, president of AHP Financial Services.

"I see no future in a 100% bond portfolio, unless the distribution rate is in the 2% or 3% range," he added.

Thomas McCarthy, senior financial planner at McCarthy & Cox, said it is virtually impossible for most retirees to finance retirement without some exposure to the equity markets, which is why he often resorts to annuity products that tie up client assets and structured notes that expose investors to issuer risk.

"If someone is really conservative they better have really low lifestyle expectations," he said.

While advisers typically reduce their clients' allocation to equities as they enter retirement, removing the growth potential of equities entirely can present challenges.

"You don't really outlive your money, but you can be forced to change your lifestyle if you don't have enough money," said Ashley Folkes, senior vice president at Moors & Cabot.

Mr. Folkes said he often sees clients who have worked with advisers on bank platforms that are so risk averse they are reluctant to stray beyond five-year certificates of deposit.

For some clients, he said the answer is structured products that keep investors exposed to the equity markets but offer downside protection.

The trade-off for that downside protection is limited upside, which can also hurt long-term performance goals.

Mr. Folkes said his preferred method of dealing with ultra-conservative clients is a simple bucket strategy that divides the portfolio into near-term, mid-term and long-term sub portfolios.

The near-term bucket, he said, might be all cash and cash-equivalent investments that can cover living expenses for up to three years.

The mid-term bucket might have a 3- to 7-year allocation objective, which will include some equity market exposure and is designed to replenish the near-term bucket.

The long-term bucket is where the riskier growth strategies are employed.

The key, according to Mr. Folkes is that the client is only focused on the certainty of what's in the near-term bucket.

Nate Creviston, wealth management analyst at Capital Advisors, is also a fan of bucket strategies for clients who don't want to think about stock market volatility.

"There are things that can be done, but you can't go to 100% bonds because any growth will be eroded by inflation," he said. "Even with our most risk-averse clients, we still need to have some allocation to stocks. The simple math with today's yields in the fixed income space would see a retiree's money have a negative real return if they only invested in bonds."

Ed Butowsky, managing director at Chapwood Capital Investment Management, said unless the client has an oversized retirement portfolio, it will be difficult to finance 25 years of retirement on a bond portfolio yielding 3%.

"If the client is that scared of the stock market, you have to just go to fixed income and then continue to educate the client," he said. "You have to have things in your portfolio that grow."


Put another way, Harold Evensky, chairman of Evensky & Katz/Foldes Financial, said, "Unless you have enough money that you can bury it in your backyard, you need to be invested."

"Too often, people confuse certainty and safety," he added. "It may be safe to sit in bonds but the only thing certain is you won't have enough money once you adjust for inflation and taxes. The risk of being invested in a diversified portfolio over a long period of time is very small."



Articles are not written or produced by the named representative and the information has not been verified. There is no guarantee as to the completeness or accuracy of the content. Quotes and remarks have been excerpted from conversations with the interviewer and may have been taken out of context. All remarks are hypothetical in nature and are intended to be informational only. They should not be regarded as investment advice, performance claims or testimonials. This is not a solicitation, recommendation or endorsement of any investment, investment strategy, tax strategy or legal advice. There is no guarantee that any strategies discussed will result in a positive outcome. You should discuss any legal, tax or financial matters with the appropriate professional. All investing involves risk and no investment strategy can guarantee a profit or protect against loss, including the potential loss of principal.

Neither asset allocation nor diversification guarantee a profit or protect against a loss.

S&P 500 Index is an index of 500 of the largest exchange-traded stocks in the US from a broad range of industries whose collective performance mirrors the overall stock market. Barclays U.S. Aggregate Bond Index is a composite of four major sub-indexes: US Government Index, US Credit Index, US Mortgage-Backed Securities Index, and US Asset-Based Securities Index, including securities that are of investment grade quality or better, have at least one year to maturity, and have an outstanding par value of at least $100 million.

Investors cannot invest directly in an index.

Inflation is the rise in the prices of goods and services, as happens when spending increases relative to the supply of goods on the market. Moderate inflation is a common result of economic growth. Hyperinflation, with prices rising at 100% a year or more, causes people to lose confidence in the currency and put their assets in hard assets like real estate or gold, which usually retain their value in inflationary times.

There are some risks associated with investing in the stock markets: 1) Systematic risk - also known as market risk, this is the potential for the entire market to decline; 2) Unsystematic risk - the risk that any one stock may go down in value, independent of the stock market as a whole. This also incorporates business risk and event risk; and 3) Opportunity risk and liquidity risk.

In general, the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities). Fixed income securities also carry inflation risk, liquidity risk, call risk and credit and default risks for both issuers and counterparties. Lower-quality fixed income securities involve greater risk of default or price changes due to potential changes in the credit quality of the issuer. Any fixed-income security sold or redeemed prior to maturity may be subject to loss.

A Certificate of Deposit (CD) is a savings certificate entitling the bearer to receive interest. A CD bears a maturity date, a specified fixed interest rate and can be issued in any denomination. CDs are generally issued by commercial banks and are insured by the FDIC. The term of a CD generally ranges from one month to five years.

A variable annuity is an insurance contract which offers three basic features not commonly found in mutual funds: (1) annuity payout options that can provide guaranteed income for life; (2) a death benefit; and (3) tax-deferred treatment of earnings. When applicable, the tax deferred accrual feature is already provided by the tax-qualified retirement plan (e.g. 403(b), IRA, etc.). The U.S. Securities and Exchange Commission (Investor Tips: Variable Annuities) has suggested that for most investors it would be advantageous to make the maximum allowable contribution to a tax-qualified retirement plan before investing in a variable annuity. The separate account of a variable annuity is not a mutual fund. While separate accounts may have a name similar to a mutual fund, it is not the same pool of funds and will experience different performance than the mutual fund of the same or similar name. In addition, the financial ratings of the issuing insurance company do not apply to any non-guaranteed separate accounts. The value of the separate accounts that are not guaranteed will fluctuate in response to market changes and other factors. Variable annuities are designed to be long-term investments and early withdrawals may be subject to tax penalties and charges. Please obtain a prospectus for complete information including charges and expenses. Read it carefully before you invest or send money. None of the information in this document should be considered as tax advice. You should consult your tax advisor for information concerning your individual situation.

The value of the shares of a Real Estate Investment Trust (REIT) fund will fluctuate with the value of the underlying assets (real estate properties.) There are special risk factors associated with REITs, such as interest rate risk and the illiquidity of the real estate market.Master

Limited Partnerships (MLPs) are a form of a publicly traded partnership. Although some units are traded on public exchanges some are nonpublic securities. MLPs generally must distribute to unit holders a majority of their distributable cash flow on an annual basis. MLPs must receive 90% of their income from qualified sources. Most MLPs are in the energy, timber or real estate business. An investment in MLP units involves risks that differ from a similar investment in equity securities, such as common stock, of a corporation. Holders of MLP units have the rights typically afforded to limited partners in a limited partnership. As compared to common shareholders of a corporation, holders of MLP units have more limited control and limited rights to vote on matters affecting the partnership. There are certain tax risks associated with an investment in MLP units. Additionally, conflicts of interest may exist between common unit holders, subordinated unit holders and the general partner of an MLP; for example a conflict may arise as a result of incentive distribution payments.

A business development company (BDC) is an organization that invests in and helps small- and medium-size companies grow in the initial stages of their development. Many BDCs are set up similarly to closed-end investment funds and are typically public companies whose shares are traded on major stock exchanges.

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