Risk Management for Individuals

Correct Answer: Implement a liability-driven investing (LDI) strategy that aligns Sophia's investments with her future liabilities, such as living expenses and healthcare costs. This approach involves allocating a portion of her portfolio to inflation-protected securities, such as Treasury Inflation-Protected Securities (TIPS), and using cash flow matching techniques to ensure that her income needs are met.

The most appropriate risk management approach for Sophia is to implement a liability-driven investing (LDI) strategy. This strategy aligns her investments with her future liabilities, such as living expenses and healthcare costs, which is crucial given her primary goal of generating a stable income stream to support her lifestyle while preserving her capital. By allocating a portion of her portfolio to inflation-protected securities, such as Treasury Inflation-Protected Securities (TIPS), and using cash flow matching techniques, Sophia can ensure that her income needs are met while mitigating the impact of inflation on her purchasing power over the long term. This approach is well-suited to her low to moderate risk tolerance and concerns about inflation. Increasing the allocation to alternative investments, such as hedge funds and private equity, may enhance portfolio diversification and potentially generate higher returns. However, these investments can be complex, less liquid, and may not provide the stable income stream Sophia requires. Focusing on maximizing portfolio returns by increasing the allocation to high-growth equities and reducing exposure to fixed-income securities may help outpace inflation over the long term. However, this approach exposes Sophia to greater market risk and volatility, which does not align with her low to moderate risk tolerance and capital preservation objectives.

Correct Answer: Implement a risk-budgeting approach that allocates a portion of the portfolio to defensive assets such as gold, US Treasuries, and high-quality corporate bonds, while maintaining a well-diversified core portfolio across various asset classes. Regularly monitor and rebalance the portfolio to ensure it remains aligned with Samantha's risk tolerance and investment objectives. Utilize options strategies, such as protective puts, to hedge against potential downside risks in the equity portion of the portfolio.

The most appropriate risk management approach for Samantha is to implement a risk-budgeting strategy that allocates a portion of her portfolio to defensive assets, while maintaining a well-diversified core portfolio across various asset classes. This approach allows her to protect her capital during market downturns while still participating in potential market upside. Regularly monitoring and rebalancing the portfolio ensures that it remains aligned with her risk tolerance and investment objectives. Utilizing options strategies, such as protective puts, can help hedge against potential downside risks in the equity portion of the portfolio. Liquidating all investments and holding cash would provide the highest level of capital preservation but would also prevent Samantha from participating in any potential market recovery and growth opportunities. It may also result in a loss of purchasing power due to inflation over time. Increasing allocation to high-risk, high-return investments is not suitable for Samantha's moderate risk tolerance and capital preservation goals. Such a strategy could expose her portfolio to significant losses during market downturns, which may be difficult to recover from, given her current wealth level and investment objectives.

Correct Answer: Jane should implement a comprehensive risk management strategy that includes purchasing long-term care insurance, establishing a healthcare savings account, and adjusting her portfolio allocation to include more defensive assets like bonds and dividend-paying stocks. This approach helps mitigate the potential impact of healthcare costs on her financial well-being while maintaining a balanced portfolio that generates a steady income stream.

The most appropriate risk management approach for Jane is to implement a comprehensive strategy that includes purchasing long-term care insurance, establishing a healthcare savings account, and adjusting her portfolio allocation to include more defensive assets like bonds and dividend-paying stocks. This approach addresses Jane's concerns about potential healthcare costs by providing insurance coverage for long-term care expenses and creating a dedicated savings account for out-of-pocket medical costs. Additionally, adjusting her portfolio to include more defensive assets helps maintain a balanced portfolio that generates a steady income stream, which aligns with her retirement lifestyle goals and moderate risk tolerance. The other two options are less suitable because they either focus too narrowly on a single aspect of risk management (purchasing long-term care insurance) or fail to address Jane's specific concerns about healthcare costs and her desire for a steady income stream in retirement.