Hang on, kid. It’s gonna be a bumpy ride, but I finally know where I’m taking you!
The Disney+ Star Wars spinoff, The Mandalorian, has gotten rave reviews by the critics and has done a good job keeping the saga alive. In it, the Mandalorian finds himself in a position to save (and save, again!) the Baby Yoda character from danger and finally to deliver him to a safe homeland. The cliffhanger of season 2 has the Mandalorian tell Baby Yoda the above quote. Season 3 of the series (still in production) deals with the continuing journey to get him to his final destination.
This saga is not unlike the journey we all take to get to our desired retirement! We all want to arrive safely, but aren’t necessarily sure where we are going or how to safely get there! Finding our way, as in The Mandalorian, requires us to avoid pitfalls that could steer us off course and to continually seek the right path to get there.
One critical misstep in your journey is to manage to an asset mix that is inconsistent with your risk capacity and risk tolerance.
The academic work on the impact of asset mix selection on long term total return is clear: though riskier, a larger allocation to equities will produce a higher total return. The challenge is to balance the risk of an asset mix against the potential return.
As seen from the table below, per the Dow Jones Relative Risk Index Series, moving from a Conservative Strategy to a Moderately Conservative Strategy results in a pickup of 2.35% in annualized total return over the 10-year horizon ended on June 30, 2021. Granted, this data table just shows one snapshot in time for a specific 10-year period and MANY forecasters are saying projected returns will be MUCH lower than historical returns from today, but the message is clear: a larger equity content shows a higher total return with more risk.
Translated to news you can use, if you have a long-term time horizon (greater than 10 years) you likely have a “capacity” to accept more risk and, consequently, earn more return. However, you also need to have a risk “tolerance” that matches your risk “capacity”! If you would not be comfortable with periodic drawdowns in your portfolio that are a normal part of the capital markets, then a lower risk strategy would be more appropriate for you with the corresponding lower expected total returns.