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POWERFUND PORTFOLIOS Since 2002
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DETERMINE YOUR RISK

Many factors help determine how risky your portfolio should be. We don’t know you, the specifics of your life, or your financial situation, and even if we did, finding your appropriate risk profile might still be difficult.

RISKY BUSINESS

Investors often assume more risk when the market has been strong, only to decide they don’t want quite so much risk following a retreat. That's why stock funds experience big inflows after big market runs, and tend to see outflows near the bottom. This "cyclical" risk profile is one of the main reasons investors tend to underperform the markets.

It's important to note that our model portfolios try to do the opposite: we assume more risk (usually more stock funds but also higher risk bond funds) as the market drops, and as fund investors cut back on stocks. If you follow a Powerfund Portfolio, and it’s now 50% in stocks, it will likely move to 55% or 60% or more if the market slides.

Since the Powerfund Portfolios get more aggressive when the market is weak, most investors should consider assuming less risk at the get-go, or they'll find it hard to increase their risk when the famous experts on TV start screaming about running for the hills.

Risk often equals volatility (how wild the up and down swings are) in a portfolio's value. In general, a portfolio's upside and downside goes up the more you allocate to stocks and higher risk bonds (high-yield junk bonds and emerging market bonds).

For risk assessment purposes, we advise investors to imagine the worst-case scenario. A decent guesstimate is that a portfolio that's 50% in stocks may fall 25% in a bad market. Generally, stocks will fall 50% every once in a while (it’s happened twice now in the last decade or so,) and factoring in some positive returns from the bond and cash side, you can expect to lose half of your stock money. (Of course, you could lose more, as this is just a best estimate). From its peak in 1929, the stock market fell about 90%. The Nasdaq fell 80% from the 2000 peak.

A ballpark downside guess for the stock market? Every 10 years, expect a 50% drop, and every 100 years, a 75% drop.

The upside to taking on more risk is generally more upside. This is not a rationale for gambling with your nest egg (after all, roulette is riskier than stocks, but you wouldn’t take your kid’s college fund to Vegas), but over time, stocks tend to beat cash and bonds.

Having said that, there are three points to consider when deciding which model portfolio is right for you:

  • The amount of income (if any) you currently need from your investments.
  • Your investment time horizon (how many years you plan to keep your money invested).
  • Your personal risk profile (how nervous a volatile portfolio makes you).

Read through the statements below. The one that points you towards the lowest risk portfolio is most likely the right choice for you.

1. How do you use or plan to use your investment income? What percentage of your investment portfolio's returns (yield) do you need now as current income to support your lifestyle?

  • If you need to live off of some or all of the yield and gains from your investments for current living expenses, you should invest in our Conservative Portfolio (and possibly consider making it more conservative – see below).
  • If you don't currently rely on any income from your portfolio, our Aggressive Portfolio may be appropriate for you.

2. How soon do you need your money? It's virtually impossible to predict how stocks and bonds will do in any given year, or even over a period of five years. What we do know is that higher-risk investments usually fall harder when the market swoons, but generally provide better returns when the market goes up.

Since it's a fairly safe bet that the stock market will be higher ten years from today, and a very safe bet that it will be higher in 20 years, you can invest in higher-risk securities to increase your returns within these time horizons. We’d add that the more stocks have fallen from a high, the higher your expected return will be from that point on, and the more risk you may want to consider taking. Stocks are less risky at Dow 5,000 than Dow 15,000, but that doesn’t mean they can’t go to Dow 3,000 before rebounding.

The longer you can leave your money invested, the more risk you can tolerate. If you need the money you're investing in just a few years, you'll want to invest in something extremely safe, since it's possible riskier investments will drop in the short term, and you won’t have time to earn your money back.

  • If you plan to use all of the money in your portfolio (not just the yield) for a major purchase (like a house or college tuition) in less than three years, and you don’t want to experience losses of more than 10% before then, consider an FDIC-insured savings account, CDs, a money market fund, or even a bond market index fund (the riskiest of the group). Either of our model portfolios could fall well over 10% in any three-year time period – even if stocks are a better deal today than they were in 2000.
  • If you have a 3-5 year time horizon, consider the Conservative Portfolio for some of your money and invest a good chunk in the above noted safer investments. What’s a good chunk? Take the amount of money you're willing to lose in a down market, quadruple it, and put that amount in the Conservative Portfolio. If you can lose 10%, 40% can be allocated to the Conservative Portfolio, while 60% should be in FDIC-backed products.
  • If you have a 5-10 year time horizon, consider the Conservative Portfolio with less or even no money in safer investments.
  • If you have more than 10 years, consider the Aggressive Portfolio, although risk-sensitive investors should still use the Conservative Portfolio, regardless of their time horizon.

3. What's your risk profile personality? Are you risk averse in life? Do you tend to toss and turn at night over minor things, especially when it comes to money, your job, or debt? We can tell you until we're blue in the face that a long time horizon means you should be in a riskier portfolio to maximize returns, but if that portfolio's swings – and there will be blood - keep you up at night, you're in the wrong portfolio.

Not only will this be detrimental to your emotional well-being, but you'll also be more inclined to sell at the worst possible time – when things look their bleakest. Therefore, you should select a portfolio with a risk level that's lower than your age, needs, income, or time horizon would normally dictate.

You want a portfolio that lets you sleep at night. If you're going to cut back on stocks after a 20%-50% slide in the market, you should start with a more conservative portfolio, perhaps even more conservative than our Conservative Portfolio.

ARE TWO PORTFOLIOS ENOUGH TO COVER ALL RISK LEVELS?

No. In the past, we had five core portfolios with increasing risk profiles, but we could argue that five portfolios isn’t enough, either. The Vanguard fund of funds (FOF) called Target Retirement owns a blend of stock and bond funds, just like our model portfolios (although Vanguard holds only Vanguard funds, while ours includes funds from ANY no-load fund family) which are designed to match your personal retirement goals and risk levels. Vanguard has ELEVEN of these funds! Some would say even that's not enough. T. Rowe Price has twelve retirement funds. (Note that the FOFs DO NOT increase the risk level as the market drops (as we often do.) They target a fixed stock allocation that shrinks as the fund, and the shareholder, age).

There are an infinite number of possible model portfolios. We're focused on making these two the best we can so you can tailor the risk to your exact needs by bringing in money market, CDs, bond index funds, FDIC insured savings accounts, etc. Heck, you can even make them riskier by adding stock indexes. When we build custom client portfolios, there are all sorts of considerations and ways in which we can increase or decrease the risk level to suit their specific needs. These two portfolios represent a good starting point for most investors. You'll have to decide if you need to adjust the risk down or up, or simply keep it as is.

Those who've been with us since we created these model portfolios in early 2002 may note that our two current model portfolios, Aggressive and Conservative, are similar in risk and return to the old Aggressive Growth and Conservative Portfolios. The old Safety portfolio was a safer portfolio, and those following it should add FDIC-insured products to their mix, as discussed above.

You can review the past history of these model portfolios on the Maxfunds site, but keep in mind that just because these portfolios fell only so much during the last crash doesn’t mean they might not fall more during the next one. This also applies to the strong returns the Powerfund Portfolios have posted relative to the S&P 500 since 2002. We may not be able to find funds that outperform the index by as great a margin as we have in the past, or time our buys and sells as well going forward.

We are not trying to scare you away from owning stocks, rather just helping you know thyself. If anything, stocks now have a higher likely return over the next ten years then they did over the past ten, and bonds will likely have lower returns. Ten years ago, we were writing about stock overvaluations relative to bonds, so consider this the opposite warning. This likelihood won’t keep you from selling low after a 30% drop, however.





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