Episode #102: How to Manage Risk with an Active Investment Strategy

LifePro Asset Management’s active investment strategies are structured to flip the traditional financial planning pyramid around by reducing market dependence and making income and principal protection the priority. In this episode of Money Script Monday, Robert presents the 3 fundamental risks that all investors face and LifePro Asset Management’s unique approach to effectively balance those risks.


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Video transcription

Hi. My name is Robert Reaburn, and today, we're going to go over how to effectively manage risk with an active investment strategy.

When we as investors deploy our capital, there's three main risks that we all face as investors regardless of size or time.

We all face what we call capital impairment risk, path of return risk, and last but certainly not least, stock and bond market risk.

Capital Impairment Risk

The first risk is called capital impairment risk. The reason why it's called that is it really centers around individual investments.

In other words, investments that are not diversified, they're highly exposed to the future prospects of an individual company or an individual asset.

There's good and bad things that come with an individual investment.

Before we even consider that type of investment, we want to understand how can we at least protect ourselves a little bit if that investment doesn't go so well?

capital impairment risk

The first thing we want to understand is, what are our liquidity needs as a household?

What are my children's needs? What are my spouse's needs? What are my own needs, in case this investment doesn't go well?

We always want to make sure we're setting aside a conservative amount of money in a side account in case this investment doesn't go well.

The second thing we want to ask is, is this investment, is the main risk return of capital or return on capital?

That is a very important question. So, when we're investing in a startup, for example, that is a return of capital issue.

In other words, your investment could turn out to be multiples of what you put into that startup or it could simply go to zero.

We want to make sure that if it does go to zero, you have enough money set aside that you can continue to live.

The second thing we want to make sure we're addressing is return on capital.

For example, if you invested in a mutual fund or another diversified pool of investments, depending on the level of volatility that you're taking on, are you getting enough return for that volatility?

Because volatility and growth are positively correlated with each other, so we should be compensated if we increase the level of volatility that we're taking on as an investor.

Where does your investment fall in the overall grand scheme of the investment world?

return on capital

We put together a nice little matrix here for you to help understand both the risk and the potential returns associated with different types of investments.

With LifePro Asset Management, we really are in what we call the top-right quadrant of the investment matrix.

What this means is, return of capital is not really the question when you invest your money with us because we invest in a highly diversified pool of individual companies.

In other words, if one company doesn't do so well, it's a very small piece of your portfolio.

While other companies are likely to offset what's going on in the other side of your portfolio.

The second thing is, we're highly liquid.

If something were to happen inside your household, or you just need access to cash in an emergency, we can liquidate all of our investment strategies in under five minutes and have that cash in any outside account within a couple of days.

Contrast that with the bottom-left quadrant here, with what we call non-registered investments.

Non-registered investments tend to be what we call single entities. It could be a single property or asset, or a startup.

Someone that's seeking money for the long-term benefit of really big returns but with also the big downside risk that you could lose your entire investment.

The other downside is that these non-registered investments do not trade on an exchange.

What that means is if you have an emergency in your life and you haven't taken our advice and set up an emergency account on the side, you will not be able to liquidate that investment for, potentially, up to six months and beyond.

Because it doesn't trade on an exchange and that creates the third issue.

That is when security doesn't trade on an exchange, you are relying on the company to provide a price that they're going to give you your money back at.

If you bought it at $10 a share, the company may say it's worth $5 a share now, so they don't have to give as much money back to you, when, in reality, it could be worth $7 or $8.

The point is, you don't know.

We consider that the fox protecting the hen house here, and that's something we just simply avoid, we don't ever want to get involved with that type of question.

Path of Return Risk

The second big risk that we as investors face is what we call path of return risk.

What this is simply meaning is, how do we manage volatility the right way, so that we're setting our clients and advisers up for long-term success?

The way to do that is we have to understand that volatility is neither a good thing nor a bad thing.

Volatility has a role in all of our portfolios.

If we're not going to touch our money for a long period of time, volatility is a function of growth.

In other words, assets that have a higher potential growth rate also have higher volatility.

That helps us deliver longer-term returns with our money.

The bad thing about volatility is if we need money in the short run, while an asset may go from $10 a share to $15 a share over 10 years, in between, it may go to $3 or $2.

If we're forced to liquidate our investment during that dip, then we take an unrealized loss and convert that to a realized loss.

So, here's the question. How do we avoid that? How do we avoid what we call that path of return risk?

path of return risk

The way we do that is through what we call time-based asset allocation.

What we want to do is set aside a small amount of money into an emergency account like we talked about at the beginning.

Making sure that if life happens, we can quickly liquidate something, we can take that cash and fund the emergency.

We charge 0% for that, that is given to all of our clients and advisers for free.

The second question, then, is how do we make sure that we dedicate a short amount of money to some of the expenditures that we're actually expecting over the next couple of years, while at the same time, we can earn a little bit of return?

A lot of the times, that could be over the next two years, the next three years.

That's where we really target our capital preservation strategy, where we increase our overall exposure to fixed income, such as corporate bonds and government bonds, and decrease our equity exposure.

What that does is it decreases volatility and your expected growth rate. The good news is that it also decreases your sequence of return risk.

In other words, if you need to quickly liquidate that portfolio, the likelihood of experiencing a big drawdown loss is very minimal.

Last, but certainly not least, is that capital appreciation.

We always talk about income, but the reality is capital appreciation accounts for over 75% of long-term stock market returns.

And it's tax-advantaged at a lower rate.

We want to make sure we can take advantage of the majority of the stock market's return.

The way we do that is by making sure for money that we're targeting growth with, that we are highly confident that we don't need that money in the next four years and beyond.

average recovery time

That really is how we discriminate between the different sources of capital in the short-term versus the long-term, so we can set you up for investment success.

Stock & Bond Market Risk

The question, then, is how do we manage stock and bond market risk?

At the end of the day, stock market risk can be separated into what we call systematic risk, which is just the overall stock market goes down 20%, 30%, 40%, and what we call non-systematic risk.

stock and bond market risk

When we think of capital impairment risk that we talked about at the beginning, let's say the prospects of a company such as Google are no longer good and you own that stock.

That is what we call a non-systematic risk, in other words, stock-specific risk.

What indexing strategies do an excellent job at is diversifying stock-specific risk at a very, very low price to you, the investor.

The downside of an indexing strategy is that it's a do-it-yourself investment strategy.

In other words, if the stock market is about to enter into a new bear market because of a recession or other issues that are taking place, is someone's going to tap you on the shoulder, and say:

"You know what? It might be time to reduce your overall exposure to the stock market and set aside a little bit more cash so that we can buy highly-valuable assets on sale later on?"

The answer is no.

In other words, if a passive investment strategy, in fact, sees the train coming, it is not going to get out of the way.

That's not the job of the index strategy. The job of the index strategy is to provide you access to the market at a very low price.

That's where an active investment strategy comes in. If we see the train coming, we can apply the brakes.

Not only do we create a diversified pool of investments that helps diversify single-stock risk away from your portfolio.

We can also make sure that if we see a pending bear market or a lot of our tactical indicators indicate a increased risk of recession.

We can apply the brakes, raise cash into your portfolio, and help protect you from some of the longer-term dangers that come from a long-term bear market.

That's really where an active investment strategy comes in.

market risk

Not only are we actively designing your investment portfolio, but we're also actively designing your asset allocation approach by setting aside short-term money to reduce your overall sequence of return risk.

While setting aside long-term money so that we can target long-term capital appreciation for your portfolio.

During the entire process, we have an emergency account set aside for you that is so you can sleep well at night knowing that:

  • You're not being charged for it.
  • No matter what happens with all of these factors of risk, you will have safe money set aside for you and your family

Thank you, again, for all of your business and for your interest in LifePro.

If you have any questions for us, or your adviser, please do not hesitate to call and ask at (888) 543-3776, and we'll be glad to answer those questions for you.

Thank you and have a great week.

The information here is presented by licensed professionals and not specific to any individual's personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstance. These videos are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable. The information presented may change at any time and without notice.
Investment advisory services offered through LifePro Asset Management, LLC, a registered investment adviser. Investments involve risk and are not guaranteed. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy will be profitable or equal any historical performance. Discussion of any specific stocks are based on objective, non-performance criteria and such discussion neither serves as a recommendation nor as the receipt of, or a substitute for, personalized advice. Due to various factors, including changing market conditions, such discussion may no longer be reflective of current position(s) and/or recommendation(s).
S&P 500 is an unmanaged index of the shares of 500 widely held, predominantly large capitalization, U.S. exchange-listed common stocks. The index results neither include dividends reinvested nor reflect fees and expenses. Investors cannot invest in any index directly.

About Robert Reaburn

Robert Reaburn is the Executive Vice President and Head of Wealth Management at LifePro Asset Management. He works with financial advisors building diverse financial portfolios that best prepares their clients for their financial future and provides peace of mind.


This information is meant for educational purposes only.

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