Are you the kind of person who enjoys a night at the casino, who knows better than betting too much but gets caught up in the excitement? Or are you someone who decides beforehand what your maximum losses should be before you even bet your first dollar?
It probably comes as no surprise that many people are wary of losing their cash at card games and the roulette wheel but don’t have the same understanding or limits when risking their wealth in the markets.
As we’re sure you know, there are no guarantees when investing your money because every investment, no matter how conservative, still has some degree of risk.
For example, if you’re investing your money in the stock of only one company, you are not diversified and your risk is very high. If this company goes through a difficult patch, the value of your stock is likely to decrease. If the company goes out of business, you could lose the entire investment. Even if you invested in a United States government bond, your investment is likely to be more secure, but even with this apparent safety, the value of that bond could still decrease.
The good news is that risk can be controlled, and a financial advisor can show you how to invest wisely, and potentially increase your wealth from an investment position that is prepared for reversals with a plan for both safeguarding and expanding your capital.
So, how much risk tolerance do you have?
Risk tolerance is a term that is defined as the amount of risk that’s acceptable for your investments given your unique financial situation. The two parts to this term are (1) your ABILITY to suffer investment losses from the risks you’re taking, as well as (2) your WILLINGNESS to suffer losses. Financially, you might be quite capable of absorbing decreases to your wealth. For example, a -20% loss might be uncomfortable but acceptable for one person, yet completely catastrophic for another.
Willingness to take a risk is often more acceptable for young people who have more time to rebuild their wealth in the event of losses, while a retiree might be completely unwilling to sustain any losses because every dollar is dear. Risk tolerance is different for everyone, and is based on their unique individual circumstances.
Of course, no one likes to see the value of their portfolio decrease, and yet it happens every day. Knowing your appetite for risk is essential before building your portfolio, and when adding or eliminating investments. Your financial advisor will be extremely helpful with analyzing risk before you add assets to your portfolio, and can help you diversify your vulnerability to risk among the assets you select while working with you to maximize your portfolio’s rate of return and minimize your exposure to risk.
When you meet with your financial advisor, your conversation may determine whether you can accept minimal, moderate, or aggressive risk selections. Many investors prefer a combination of these three levels of risk, and depending on their tolerance for risk, they may have a more conservative portfolio with a few moderate and aggressive investments, or they may choose a more aggressively focused portfolio because other factors in their estate, or overall wealth, are secure.
Most people do not want to throw the dice when it comes to their financial well-being and the effect an aggressive approach may bear on their retirement years. I am reminded of the two sides to the risk tolerance coin in these quotations:
“Risk is like fire: If controlled, it will help you; if uncontrolled, it will rise up and destroy you.” ~ Theodore Roosevelt
“If you risk nothing, then you risk everything.” ~ Geena Davis
We hope this article about understanding your personal risk tolerance was informative, and gave you some ideas about how to approach risk when you make investments. We welcome your getting in touch with us so we can review your portfolio and financial requirements. We would also welcome helping you determine if you’re on the right track for the retirement lifestyle you desire. Thank you!
Joseph M. Maas, CFA, CVA, ABAR, CM&AA, CFP®, ChFC, CLU®, MSFS, CCIM
Synergy Financial Management, LLC
13231 SE 36th Street, Suite 215
Bellevue, WA 98006