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Risk Tolerance Metric: Loss to Income Ratio

beebee
in Off-Topic
Haven't posted in awhile...just enjoying life. Hope all here are well.

This read help impress on me the importance of understanding my risk tolerance...especially when my portfolio is in the withdrawal phase of life.

From the article:
...if you have a $100,000 portfolio and it drops by 30% in a bear market while your annual income is $50,000, the LTI is

$100,000 * 30% / $50,000 = 0.6

It means that you lose from your investments 0.6 years or 7.2 months worth of your income. If you think that’s acceptable, then the portfolio’s risk level is OK.

...if the same investor has a $1 million portfolio, a 30% loss means a potential loss of 6 years worth of income. I don’t know about you but I’m OK with losing 7 months worth of my salary but losing 6 years worth of my salary is just too much, even though the portfolio loss percentage is the same.

On the other hand if this investor has a $10,000 portfolio, the same 30% loss is not even one month worth of salary, which can be replenished relatively quickly.
link:
risk-tolerance-metric-loss-to-income-ratio

Comments

  • InvestorInvestor
    I don't think LTI is meaningful. If you only had $100K, that means you only have 2 years of money to live. That is a big big problem. On the other hand if you had $1M portfolio and after loss you will have $700K which means 14 years of money left and meanwhile bear markets come and go and your portfolio is going to go through the recovery phase (if you do not get scared and move to cash after losses incurred) and you will recover the money and extend that 14 years more.

    If you want you can divide your portfolio into 3 segments.

    Part 1) Short term needs. Put the money for living at least 3 years of expenses. Invest in short term vehicles. Part of it could be in bonds. This part is large enough so that you can live through a bear market of a couple years.

    Part 2) Intermediate term needs. Put the money for needs coming up in 3-5 years. This could be some low volatility funds, intermediate term bonds or 5 year CDs. There may be some fluctuations in the funds but left to its own they will generate some modest growth over 5 years.

    Part 3) Invest this part for growth in mind. This part will experience volatility. So, invest in a sensibly diversified portfolio of stock funds and do not mess around a lot with this portion. It will ride up and down and yes if a crash occurs it will be hit but if you do not withdraw after crash you will be OK since the horizon is OK.

    Once a year do a rebalancing of the portfolio so part 1 and 2 is roughly maintained in the sizes you need.

    This is basically what insurance companies do. They match the risk to the term of obligations.
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