Should My Risk Tolerance Change?
by Trey Finch
For many, buying a house, starting a family, and retirement are common milestones that we aim to achieve as we set out in our careers. It is important to bear in mind how these checkpoints in life may shape your investment choices. Investors in these situations may want to do an inventory of their risk tolerance as they achieve these milestones since there is often little room for error if things don't go according to plan.
What is Risk Tolerance?
Risk tolerance is the degree of variability in investment returns that an investor is willing to withstand in their financial planning journey(cite Investopedia definition). It can help you understand your ability and willingness to endure swings in the value of your investments. More importantly, when understood fully, it can help you remain comfortable during a market drawdown – where you may want to sell your investments at a bad time.
Factors like income, age, and stage of life can significantly influence how much risk capacity you consider tolerable. During phases of market volatility, like we have begun to experience in 2022, it is especially important to re-evaluate your tolerance since some of the most stable and dependable assets can generate lower returns in a rising interest rate environment.
Explore answers to the following:
- How should your time horizon factor into your risk?
- Why is diversification important for your portfolio?
- What may help reduce the risk in your portfolio?
- Do you find yourself trying to time the market?
- How important is staying the course and focusing on a long-term focus?
- How important is a potential investment’s long-term performance?
If you cannot bear the idea of ever taking a loss, your tolerance is low. Conversely, if you find yourself interested in speculative investments or investments with little to no track record, then your tolerance is likely high.
The higher your risk tolerance, the more likely you are to invest in stocks and other high-risk options. The lower it is, the more likely you are to invest in bonds or other low-risk options. In many cases, investing is simply a waiting game—meaning that it is often best simply to wait out stormy markets, knowing that calmer seas are typically ahead, eventually.
Nevertheless, volatile markets can also expose non-diversified and concentrated portfolios making them especially painful to own. To avoid this, you may want to consider reviewing your asset allocation annually to avoid your portfolio becoming overly concentrated in a few areas. This annual practice lends itself naturally to inventory whether anything in your life has changed significantly to alter your risk tolerance.
Be sure to consider your time horizon (the length of time until you will need access to the money invested) when you sit down for your rebalance. For example, if you are young and years away from drawing down your investments, it may be acceptable for you to take on some additional risk – because. There is time for you to ride out downturns in the market.
However, if you have less time before needing access to your funds, then it is probably best not to take on additional risk because there is less time for those risks to pay off. Similarly, if a market correction should wipe out most of your nest egg, you may not be able to recover sufficiently before leaving the workforce
Revisit Your Tolerance
Most investors’ tolerance for risk changes over time. So, it is important to be aware of how your time horizon and life milestones can (and might) affect your investing. Generally speaking, an asset’s risk level should be commensurate with potential returns and it’s important to keep a pulse of this.
Things To Consider When Investing
There are many moving parts that you should consider when investing during market volatility. Most of all, you should diversify your portfolio to mediate risk. The following are tips on how to do that:
- Don't put all your eggs in one basket. Spread out your risk by investing in different asset classes such as stocks, bonds, and real estate. Mix in some international holdings! That way if one investment goes down, another may go up—that is the power of diversification.
- Gather insight from an investment advisor when choosing which investments are right for you. It’s important to ensure that the stocks, mutual funds, or exchange-traded funds (ETFs) align with your time horizon and goals.
- Consider allocating a portion of your portfolio to alternative investments, like real estate or commodities. These may be more stable and are often less correlated with stocks and bonds because they don't always move in lockstep with the market.
- “Be greedy when others are fearful” – Warren Buffett. It is easy to get FOMO (fear of missing out) when times are great in the market – just look at the spike in cryptocurrency and Non-Fungible Tokens (NFTs) over the past few years. Conversely, the fear of a falling market can be paralyzing (also see cryptocurrency and NFTs). Sometimes the best time to invest in the stock market is when things appear to be on firesale – but it all comes down to where you are in your investment journey.
Investors should always be thinking about how an investment will perform over time; not whether they will make money on any given day or month or year. If you look at historical data, you will see that stocks can fall for years at a time before they start climbing again.
In other words, consider taking advantage of the dip to buy more stocks at a discount. This might sound counterintuitive, but it is based on decades of research showing that investors do better when they buy stocks during market downturns than during bull markets.
The reason is simple: When markets are going up, everyone has a stake in participating in that growth, including investors who missed out on earlier gains. Conversely, when markets go down, investors tend to be less optimistic about their prospects for growth and pessimistic about their ability to recover from losses.
Often, they decide not to buy anything at all until volatility calms or until prices go back up. This creates a ripe opportunity for those who have been patiently holding onto cash, have experienced a financial windfall, or are savvy enough to tilt their portfolios towards equities from other holdings.
At TrustCore Financial Planning, we want to be more than just your financial advisor in Brentwood, Tennessee. Our case studies reflect our track record, but we have other resources for you as well (including a complimentary eBook) Schedule a free meeting to start benefiting from our years of experience in asset management.
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