Nerdy post alert! We need to discuss risk tolerance. It’s not the most exciting stuff, but it’s very, very, very important to understand. So grab a cup of coffee, or a glass of whatever moves you (no judgement here), hang in there, and read on.
Bad news and good news.
First, let’s tackle the bad news. You have no control over what the stock market does every day. The market’s ups and downs are the result of millions of individual people making decisions. All those decisions combined determine which direction investments move. The market can soar one day and tank the next, or do basically nothing for days on end, and there’s really not much of anything you can do about it.
Sound frightening? It certainly can be. But fear not, because here’s the good news! While you have no control over the market, you do have 100% control over the makeup of your investment portfolio (psst…your portfolio is the combination of all of your investments). Knowing what you have will make you better able to handle those wild market rides. You can figure out which investments are right for you by knowing your risk tolerance.
Mmmkay…what is this thing you call Risk Tolerance?
Risk tolerance is your ability, or inability, to handle the ups and downs of the stock market. There is a wide range of risk profiles, from conservative to aggressive, based on many factors such as personality, age, time horizon, goals and investment experience. Where you fall on the spectrum depends on your personal situation, and everyone’s risk tolerance is different.
What can happen if someone’s investments are too aggressive, or too conservative?
Too Aggressive: When a person’s investments are more risky than they’re comfortable with, it can lead to poor decision making and irrational selling. It often goes like this: Market volatility causes investment markets to take a nosedive, and folks that are too aggressive make knee-jerk reactions and sell their portfolio low, instead of staying in for the long haul. The thing we all should keep in mind is that recessions and the scary investment markets that come with them happen pretty regularly, about every 6 or so years. If your investment portfolio is too aggressive, it makes it hard for you to weather those rough times without panicing.
Too Conservative: Those who have portfolios that are not risky enough lose out on the potential for greater gains in the long run. Generally speaking, when evaluating investments, greater risk should lead to greater reward. If you invest too conservatively, your portfolio could be chronically underperforming. Underperformance over many years is No Bueno, and will ultimately make it more difficult to reach all those wonderful goals you have for the future.
Example: Millennials and Risk Aversion.
Millennials in general fall in the “too conservative” category of investors. We just don’t want to lose our hard earned money, so we tend to stay on the sidelines or in portfolios with significantly less risk than is called for. We lived through the last recession, and watched as our parents’ retirement savings were cut in half, and we certainly don’t want that to happen to us.
But here’s the kicker: one of the major reasons that our parents suffered so much is because they were often invested in portfolios that were too risky. The market tanked, they got scared, and they sold their portfolio to try and save what was left. Unfortunately, selling at the bottom made it so they didn’t recover as the market did. Now that retirement age is here, those same parents are finding it more difficult to live comfortably in retirement as they have a smaller nest egg than they had originally planned.
What’s the endgame?
So here’s the major lesson to take away from all of this: You need to invest so your savings can grow! Being in your 20’s and 30’s means that you have time on your side, and have decades to invest in the market before using that money for retirement. Take control and run with it. Find out your risk tolerance, have a financial plan, invest in a portfolio that’s right for you, and you’ll be well on your way to financial success.
Where we come in.
Our goal is to show people that investing is approachable. It isn’t about closing your eyes and hanging on for some wild ride. It’s about knowing where you stand, and being in control of what you can control – the risk level of your investments. Here’s how we do it:
- Step 1: Assess your risk: All of our new clients complete a short risk tolerance questionnaire, which will show you exactly where your comfort level is.
- Step 2: Invest you in a risk-based portfolio: Your funds are put into investments that are right for you, based on where you fall on the risk spectrum.
- Step 3: Re-evaluate and re-allocate: Your life will change, and so will your risk tolerance. Maybe you buy a house, get married, or change career paths. We’ll regularly assess your risk tolerance and re-allocate your portfolio over time to make sure it’s in line with where you are.
You have tons of things to worry about every day. The ups and downs of the stock market shouldn’t be one of them. Time is on your side to invest and grow your savings, so when retirement is near, you’ll have what you need. Take control now, and you’ll be way better off in the future.