Is it time to reassess your tolerance for investment risk? |
Each investor has a unique investment approach, risk tolerance and time horizon based on their personal circumstances, goals and preferences. But all investors should decide what level of risk is right for them up front, and then strive to stick with that investment strategy. To help you, you can ask yourself these three questions:
1. How much can I bear to lose emotionally?
The assets that offer the highest potential reward are often the riskiest. Portfolios with larger allocations to equities typically generate higher returns over time, but they are also more volatile. The objective of an “investor” is generally to obtain higher investment returns than low risk returns – cash and CD. In order to achieve these results, you must accept a certain level of fluctuation in the portfolio.
To help you manage your emotional reaction to market volatility, consider reducing the frequency with which you review your account performance over the long term. In fact, research suggests that the less people check their investments, the more comfortable they will be in taking risks.
2. How much can I have to lose financially?
While many people think of risk in terms of being able to bear losses emotionally, there is another element of risk that is just as important: your ability to recover financially.
Time is the main issue here. Those with a decade or more to expect to dip into their savings can likely expect some short-term volatility. For someone who might need the money sooner, say in three years or less, a market downturn can be worrisome.
Consider designing a portfolio that contains enough cash / stable assets to cover at least 36 months of living expenses. This avoids selling investments when the market is negative and allows time for investments to recover.
3. Do I know myself well?
It’s worth trying to match your financial capacity for risk with your emotional tolerance for it. What makes this difficult is that humans are notoriously bad at predicting in advance how they will actually react to a given set of conditions.
You could try asking a loved one to assess your tolerance for risk. It could be a spouse, close friend, or your financial advisor. A financial advisor may be well suited for this role; their experience with a wide range of clients can give some idea of where you stand in the risk tolerance spectrum.
Ultimately, figuring out how much risk you can really handle is an art as much as a science. But when you have a better idea of what you can lose – both emotionally and financially – you can craft a plan that balances your need for long-term growth with the more immediate need to be able to sleep at night.
Personally, I believe in a well-diversified and balanced approach. If you would like to review your portfolio and assess your risk, please contact us for a free portfolio review.
Philip Bailey is the Branch Manager at the independent Charles Schwab branch located in Southern Pines with over 18 years of experience helping clients achieve their financial goals. For more information, visit the independent Southern Pines branch website at: www.schwab.com/southernpines or call (910) 684-4965.
* The information here is for general information purposes only and should not be construed as an individualized recommendation or personalized investment advice. Diversification asset allocation strategies do not guarantee a profit and cannot protect against losses in a falling market.