Risky to Not-So-Risky Ratio

You may have heard what I call your risky to not-so-risky ratio referred to as a stock to bond ratio. They’re basically the same thing; However, I always felt stock to bond ratio shortchanged us investors as far as choices go. There are lots of alternative investments to stock on the risky side and bonds on the not-so-risky side.

That’s not to say your risky to not-so-risky ratio might not end up all stocks and bonds. Stocks and bonds are the more popular choices on their respective sides for good reason, and oftentimes you’re stuck with just those choices through no fault of your own, like with a 401(k)-type plan offered by your employer.

Still, with the many new investing products already out there and more on the horizon, I’m sticking with my longer, more accurate description. Even though risky to not-so-risky ratio doesn’t role off the tongue like stock to bond ratio does, it is a more accurate depiction of your choices on both sides.

Risky Investments

  • Commodities (Precious metals, agricultural and energy products using commodity futures)
  • Crypto Currency (Bitcoin and a host of others)
  • Derivatives (Forwards, Futures, Options, Swaps)
  • Real Estate (REITS, real estate mutual funds, limited partnerships)
  • Stock

Not-So-Risky Investments

  • Bonds
  • Certificates of Deposit
  • Money Markets
  • Savings Accounts
  • Ultra-Short Bond ETFs

Please proceed with caution when choosing any investment, but especially the riskier more volatile ones. You’ve got to know what you’re doing before investing in them. For example, should you include crypto currency on the risky side of your ratio? Only if you’re knowledgeable on the subject and willing to keep abreast of the market on a daily basis should you even considerate it, and I’d keep your percentage of holdings in the low single digits. Why? Extreme volatility.

I’m not picking on crypto investors here. I’d say the same thing about any super-volatile investment, including derivatives, emerging international markets, and “C” rated junk bonds.

Time Horizon and Risk Tolerance

Use time horizon and your own risk tolerance for investment to determine your risky to not-so-risky ratios. Do it for all the goals you’re saving for, and for all the individual years in each plan. That’s the first step in creating customized investment plans for all the goals you’re saving for.

The longer your time horizon for investment, the more aggressive you want to be with your ratios. This is true whether you’re a super-aggressive investor, a super-conservative investor, or anywhere in between. Make your ratio more risk-heavy the longer the time horizon.

The shorter your time horizon for investment, the more conservative you want to be with your ratios. Again, this is true no matter what your risk tolerance. Keep in mind that your time horizon for investment, the time between now and your goal’s fruition, is continually getting shorter, which is why your risky to not-so-risky ratio needs to be dynamic. It needs to change from more aggressive to less aggressive.

You’ll be making these changes once a year if you follow my advice. That’s when you’ll be making the necessary changes to not only rebalance but move from a more aggressive stance to a more conservative one when your plan calls for it.

One Year or Less Goals

When your time horizon is one year or less, your risky to not-so-risky ratio should be super-conservative. Maybe you’re saving for your emergency reserve fund, tuition, or a vacation, and your time horizon started out as one year or less. Or your once short or longer-term goal’s investment plan is now down to its last year.

Either way, your risky to not-so-risky ratio should be 0-100 for that one-year term. If a bubble hits and you’re still investing on the risky side, that goal isn’t going to happen. That means you should be out of those risky investments completely and investing on the not-so-risky side exclusively. This is true regardless of your risk tolerance if you’re serious about goal attainment.

Short-Term Goals

Short-term goals include those that started out with a time horizon of 2-4 years, as well as longer-term goals that have matured into short-term goals. More aggressive investors may still have some money on the risky side here, but much less than earlier and with the percentages decreasing each year. More conservative investors may still favor a 0-100 risky to not-so-risky ratio during this time.

Longer-Term Goals

Longer-Term goals with time horizons 5 years and greater afford the opportunity to make some real money. Even conservative investors will want to get more aggressive and increase their risky percentages with these longer time periods, knowing there is ample time to recover from a bubble. The longer the time horizon the higher the risky percentages.

Rather than changing your investment plan all at once from risky to not-so-risky, do it gradually over the life of the plan. This insulates you from risk even more and helps with a “soft landing” with less volatility.

Retirement Example

Let’s look at two investors with the same 20-year time horizon for retirement, one aggressive and one conservative. Because of their different risk tolerances, their risky to not-so-risky ratios won’t look the same. Both, however, never have a riskier plan next year than last year, and both decrease their risk along with their time horizon.

Year ~ Risky Ratio (Conservative)-Not-So-Risky Ratio (Conservative) ~ Risky Ratio (Aggressive)-Not-So-Risky Ratio (Aggressive):

1 ~ 55-45 ~ 100-0

2 ~ 54-46 ~ 100-0

3 ~ 53-47 ~ 97-3

4 ~ 52-48 ~ 94-6

5 ~ 51-49 ~ 91-9

6 ~ 48-52 ~ 88-12

7 ~ 46-54 ~ 86-14

8 ~ 44-56 ~ 84-16

9 ~ 42-58 ~ 82-18

10 ~ 40-60 ~ 80-20

11 ~ 37-63 ~ 78-22

12 ~ 36-64 ~ 76-24

13 ~ 34-66 ~ 74-26

14 ~ 32-68 ~ 72-28

15 ~ 30-70 ~ 70-30

16 ~ 28-72 ~ 69-31

17 ~ 26-74 ~ 68-32

18 ~ 24-76 ~ 67-33

19 ~ 22-78 ~ 66-34

20 ~ 20-80 ~ 65-35 (expected retirement date)

College Savings Example

Once again let’s look at 2 investors, one conservative and one aggressive, who are now faced with a college savings goal and a 10-year time horizon.

Year ~ Risky Ratio (Conservative)-Not-So-Risky Ratio (Conservative) ~ Risky Ratio (Aggressive)-Not-So-Risky Ratio (Aggressive):

1 ~ 15-85 ~ 70-30

2 ~ 12-88 ~ 65-35

3 ~ 9-91 ~ 55-45

4 ~ 6-94 ~ 45-55

5 ~ 3-97 ~ 35-65

6 ~ 2-98 ~ 30-70

7 ~ 1-99 ~ 25-75

8 ~ 0-100 ~ 20-70

9 ~ 0-100 ~ 15-85

10 ~ 0-100 ~ 10-90 (first year of college)

Varying Disbursement Periods

I assumed a 4-year college disbursement period in my example, which is why the risky percentages are much lower at the goal’s fruition when compared to the retirement example, which is assuming a 25-year disbursement period. Whether conservative or aggressive, you still need some risk in your retirement plan at the beginning of retirement. That risky money is invested for those latter years of retirement where a long time horizon for investment still exists.

By the time you near retirement age, or by the time your son or daughter nears high school graduation for the educational goal, be sure to fill in the risky to not-so-risky ratios, as well as the dynamic diversification, for the disbursement years too. Use the same logic you’ve been using, and make sure money is not only withdrawn from the not-so-risky side, but from the least risky accounts.