The term ‘risk parity’ isn’t something most physicians come across often (or, let’s be honest, ever). But for financial advisors, risk parity is a tool that is just as important and familiar to us as your stethoscope is to you. A stethoscope gives you the information you need to determine if a patient needs treatment. Risk parity gives our team at Soaring Investment Management the information we need to determine if your portfolio needs treatment. Of course, we’re not prescribing medications or other healthcare strategies to make your portfolio ‘well.’ Instead, we use the information provided by risk parity to maintain the health of your portfolio over the long term.
What is risk parity, exactly?
Risk parity is a portfolio allocation strategy that uses risk factors to determine the most appropriate allocations of various asset components within your investment portfolio. Risk parity strategies (there are many) use modern portfolio theory (MPT) to help optimize—and hopefully maximize—your expected return while assuming a certain level of market risk. (Remember, returns are your reward for taking a measured amount of investment risk.) In a general sense, risk parity attempts to neutralize some of the risks of investing that go hand-in-hand with market timing.
Market timing, of course, is the process of attempting to buy assets when they are cheap and sell them when they’re expensive. In the short term, many investors would agree that this is a pretty tough way to make money. However, risk parity helps smooth the process of market timing by taking steps to overweight assets that are cheap (as measured by multiple metrics), and then slowly shift the investment into other assets by selling those once-cheap assets as they become more expensive over time. Rather than relying on a static equation—such as the standard rule of thumb of 80% equities and 20% bonds, for example—risk parity considers a much broader group of assets and alternative strategies to attempt to achieve optimal outcomes. It’s a strategy that many investors find very useful, including Bridgewater, the world’s largest hedge fund, which credits much of their success to risk parity strategies. (If you want to learn about the technical details and benefits of risk parity, this white paper from Bridgewater is a great primer.)
How can risk parity help strengthen my portfolio?
At Soaring, we use a variety of strategies to help partner physicians seek better outcomes in their individual portfolios. Often, the approach we find most beneficial is a risk parity model. Since different types of assets tend to change in price and value throughout each market cycle (which typically lasts about 10 years or so), risk parity allows us to track and manage the assets in your portfolio at any given time based on the current level of risk for each asset class. Risk parity helps us determine when to buy and when to sell based on larger market trends.
Risk parity also supports the retirement planning process. Like most partner physicians we work with, you are probably investing primarily to maintain your lifestyle after you retire. By incorporating risk parity strategies into your retirement timeline, we can more easily protect your assets from the wrong risk at the wrong time. For example, a risk parity model might identify growth stocks as an ideal opportunity when you are in your late 40s and have a decade or more to grow your assets. However, in the year or two leading up to your retirement, the model might identify this same asset class as too risky because the chance of those assets losing significant value in the short term may be higher. Based on your timeline, the model may suggest reducing the percentage of growth stocks in your portfolio to reduce your risk at a time when a major loss could have a greater long-term impact on your wealth.
Putting risk parity to work for you
Risk parity strategies are most effective when applied to portfolios that include a highly diversified set of assets with a very low correlation (meaning that the asset classes typically behave differently in various market scenarios). The more asset classes there are in the equation, the easier it is to find those that are cheap, identify those that are getting expensive, and shift the portfolio appropriately. It’s just one more reason why expanding your ‘menu’ of assets and creating a well-balanced and diversified portfolio is so important.
Diversification should always be a priority for investors who want to minimize risk. Working with a financial advisor who offers access to a much larger group of assets than what is found in your employer-provided plan is the easiest way to increase the diversification of your assets—and to take advantage of risk parity strategies that can help you buy low and sell high with as little risk as possible. If you’re ready to take that next step, please reach out. As always, we’re here to help!
