Portfolio management How can investors make their finances more resilient?

This combination of threats highlights the need for strategies that bolster financial resilience. This, in our view, goes beyond efforts to reduce short-term volatility through hedging or holding safe-haven assets, important as this can be. Instead, financial resilience should be a broad plan that improves the chance that an investor will achieve their financial targets, which can, for example, even involve taking on more risk.

What is financial resilience?

Financial resilience is a measure of how robust a financial plan and money are to shocks.

Entrepreneurs and investors frequently set themselves longer-term financial goals, for example building a retirement pot, saving for children’s college fees, or raising money for a business acquisition. Meeting these long-term objectives will likely require a financial plan and the money to put that plan into action.

For some, financial resilience is the ability to change their goals—for example to abandon a business acquisition or delay retirement—if financial markets do not perform as expected or the raise at work never materializes.

Others may regard themselves as financially resilient if their portfolio delivers the returns needed to reach a financial target at the time it’s needed.

The ideas of financial resilience and perceived safety are connected. But defining safety as holding just low-risk instruments like cash could be a mistake, especially for achieving far-off objectives.

How can investors ensure greater resilience?

We’ll focus on three ways business owners and investors can boost their financial resilience.

1. Build up a sufficient (but not excessive) buffer of cash

Save some cash and buy some lower-risk assets that can be readily sold. Now the key aspect here is not: “Should I hold cash?” Rather, it’s: “How much cash should I hold?”

In times of turbulence, it’s tempting to boost cash levels to bolster a sense of short-term financial resilience. But that strategy can undermine long-run financial resilience by sacrificing long-term returns from riskier assets and holding excess cash whose value is eroded by inflation.

We believe investors and business owners would do well to ask how much cash they, their businesses, and families need for the next three to five years. This number should determine the size of a liquidity strategy of cash, less-volatile instruments, and available credit.

Holding liquidity sufficient to cover one's needs for the next three to five years minimizes one's chances of needing cash, facing financial losses, or locking in losses by liquidating securities at their lowest levels.

2. Invest in a well-diversified portfolio

One will often hear this encouragement from professional investors, so let’s explore the concept in a bit more detail. Long-term financial resilience depends on having enough money to meet one's spending goals when one needs it most. So clearly generating financial returns matters. A well-diversified portfolio, spread across asset classes, geographies, and sectors, is one way to generate positive financial returns that grow one's money throughout the economic cycle.

Diversification can give an investor exposure to a variety of assets that thrive through different external threats. One asset might rise with higher oil prices, while another might gain on a depreciation of your home currency, higher US interest rates, or tougher sustainability regulations. Having the money to hand when it is needed depends on portfolio value swings, in other words portfolio volatility. Diversification offers intrinsic protection against bear markets, and hence a financial resilience boost.

3. Take the long view and look for alternatives

Long-term financial resilience may rise if an investor holds assets that reduce swings in the value of their wealth by decoupling from traditional investments like stocks or bonds. These volatility-dampening assets can include hedge funds, private markets, and infrastructure. These alternative investments have historically reduced portfolio losses during the sharpest market downturns, which is when business owners and investors seek financial resilience the most.

Financial resilience matters most to entrepreneurs and investors when the world feels shakier. Business owners and investors may be particularly interested in building financial resilience now, given that financial markets continue to reprice the consequences of the war in Ukraine and the implications for commodity prices, economic and earnings growth, and how policymakers will respond to meet their price stability targets.

For much more, see the CIO Tutorial: How can investors make their finances more resilient? 29 March, 2022.

Main contributors: Matthew Carter and Christopher Swann

This content is a product of the UBS Chief Investment Office.