I've spoken before about the high-net-worth mindset – the connection between the way wealthy individuals think and what they're able to achieve financially.
One critical component of this mindset is what I call a "risk first" attitude. Yes, HNW individuals care deeply about performance. But when they think about performance, of a specific investment or of their portfolio as a whole, they think about it from a perspective of how much performance they're getting for how much risk they're taking on.
This strikes me as a particularly important point right now, as a number of market signals suggest we may be heading into a period of increased volatility in which the question of how much risk to take on will matter a great deal.
Over the past 30 years, I've come to understand this way of thinking about risk as a critical component of HNW investment success. Thinking "risk first" makes a profound difference to how you approach investment selection and portfolio construction.
HNW individuals tend to be extremely proactive when it comes to risk and more aware of the role risk plays in their overall financial plans. They're more likely to view risk management as an important goal (in many cases, it's the primary goal). And they're more likely to understand how long-term financial success doesn't always depend on selecting superior performance, but rather on avoiding capital-destroying risks.
This is somewhat different from what we might respectfully call the "average" investor. The average investor is typically focused on performance first – risk becomes a consideration after an investment idea doesn't work out or after the market suffers a downturn. By then it's often too late, the damage has been done, and it may take years to repair it.
Instead of simply letting risk "happen," HNW investors ask themselves three important questions:
How much risk can I accept?
This question addresses financial capacity: what the investor can reasonably do given current financial or life circumstances.
What is my current financial situation (including income, assets, liabilities, return, interest rates and time horizon)? How are the various portions of my portfolio meeting their stated objectives and my life goals? How much of my assets are allocated to high-growth, speculative or "mad money" investments? Does a specific opportunity align with my predetermined risk limits? Am I buying assets at steep discounts or am I overpaying for them just because others are? For example, today's equity and bond markets are expensive relative to history.
These answers serve to filter new opportunities and act as a "gut check" for existing positions, to ensure risk doesn't creep into the portfolio over time.
How much risk do I need to accept?
This question focuses on understanding long-term financial and lifestyle goals.
What goals will I need to meet in order to fund my future? What are my expenses over the next one, three, five years? What rate of return do I need from my overall portfolio to achieve those goals? Does a specific investment opportunity get me closer to those goals?
These are the bedrock questions of financial planning – but HNW investors don't approach them as "set it and forget it" questions. Rather, they are constantly revisiting them, re-evaluating their needs and re-aligning their portfolios to those needs.
How much risk do I want to accept?
Perhaps the most important question of all revolves around the individual's emotional appetite for risk.
How do I feel about risk? How do I respond to it? At what point do I lose sleep over it? These questions are simple to ask, but the answers require a profound level of honesty and emotional self awareness. Ultimately, successful HNW investors understand that investing is about achieving risk-adjusted performance, and a large part of that is understanding your personal emotional makeup.
This "eyes wide open" approach to risk is a big part of how the wealthy are able to remain disciplined investors. When an opportunity is too risky, they know before they get into it. When it becomes too risky after the fact, they know to get out of it. Instead of worrying about hitting home runs, they focus on avoiding strikeouts. It's a good strategy for any investor to follow – even more so now.
Thane Stenner is portfolio manager and director of wealth management of StennerZohny Investment Partners+ within Richardson GMP. He is a founding member and chairman emeritus of TIGER 21 Canada and author of True Wealth.