Risk & Allocation
A worst case written down is easier to hold
Describing in advance how far a portfolio could fall, in cash terms, converts an abstract risk into a scenario that has already been considered when it arrives.
Risk tolerance is usually assessed with questions about hypothetical percentages. Writing out a specific worst case, in money, produces a more useful answer and a more durable one.
Abstract risk is not felt in advance
A stated willingness to accept a decline is a prediction about a future emotional state. Predictions of that kind are systematically optimistic, because the state is not being experienced.
The gap only closes during an actual fall, which is the least useful moment to discover it. By then the decision has to be made rather than considered.
Converting the percentage into a cash amount narrows the gap considerably. Money has a felt magnitude that a proportion does not, and the reaction can be tested against it.
Writing the scenario in full
A useful written scenario states the size of the fall, the resulting balance, how long the decline might last and what would be happening in the world at the time.
Duration is the part most often omitted and the part that does most of the damage. Falls that recover quickly are tolerable; ones that grind on for years test everything.
Including the context matters because falls do not arrive without a narrative. There is always a compelling reason to believe this time is different, and the document should say so.
The document is addressed to a different person
The version of you reading it will be worried and looking for permission to act. The version writing it is calm and has time, which is why the writing has to happen first.
What the document supplies is evidence that the situation was anticipated. That does not make it comfortable, and it removes the sense of being in unmapped territory.
It also records the reasoning. A decision revisited under pressure is much easier to sustain when the original argument is available rather than reconstructed from memory.
It is a test of the allocation, not of resolve
If the written worst case is genuinely unacceptable, that is information about the allocation. The correct response is to change it now rather than to resolve to be braver.
An allocation that can only be held by someone unusually calm is not suited to whoever actually holds it. Fit is a property of the pairing, not of the portfolio.
Adjusting it in advance costs nothing beyond a lower expected outcome, which is a known trade. Adjusting it during a fall costs the fall itself.
Rereading it beats rewriting it
The document should be revisited at the annual review and changed only when circumstances change. Rewriting it because markets moved defeats the purpose entirely.
Its value comes from having been written by someone with no stake in the current moment. Editing it under pressure removes exactly the quality that made it useful.
Where the balance has grown substantially, the cash figures need updating, since a scenario written against a much smaller portfolio no longer describes the amount at stake.
Questions readers ask
Is a target date fund a good default?
For somebody who would otherwise never adjust anything, it does a job that would not otherwise get done. It is weaker where a lot of your wealth sits outside it.
What does to versus through mean?
Whether the fund stops adjusting at the target date or continues reducing risk for years afterwards. The two produce quite different allocations on the day you retire.
