Steven Walraven, CFA
November 7th, 2019
“The greater the risk, the greater the reward.” It’s a statement we’ve all heard. Taking on more risk with your investments may increase your likelihood of higher returns, but you may also experience the downs of the investment markets, including the risk of losing some or all of your investment.
There are many different kinds of risk. One of those is market risk. That’s the chance the value of an investment will go down, not up, causing you to lose money. The second is the possibility that you may not earn enough on your investments to keep up with inflation. And a third common risk is the chance your investments won’t grow enough to get you to your longer-term goals, such as retirement.
Understanding Your Risk Tolerance
There are a number of factors that can help determine your risk tolerance:
- What is your time frame? The length of time remaining for you to reach your goal matters when it comes to how much risk you can handle in your portfolio.
- What can you afford to lose? Another key consideration is how much investable money you have available after identifying your goals and obligations, and how much you can afford to lose.
- What is your emotional ability to handle risk? Some people can’t handle the ups and downs of the markets and, therefore, are better off choosing a more conservative portfolio.
Investors need to be savvy, always balancing the risks they are taking with the possible rewards — and avoiding investments that are beyond their understanding or individual tolerance for market volatility.
Investing for the Long Term
When investing for long-term goals, it is important to be prudent and stay focused on the long view. Prices of stocks and bonds can go up and down, sometimes wildly. But if you’re thinking in terms of years and not days, the short-term peaks and valleys won’t seem so large.
A prudent investor helps manage risk by diversifying — spreading money among different kinds of investments that are not correlated to each other. Of course, diversification cannot guarantee a profit or protect your portfolio from losses.
Not Too Much but Not Too Little, Either
It can actually be risky to take too little risk. A person in their 20s, who puts all of their retirement savings into conservative investments isn’t at much risk of losing their money. But they may be at risk of running out of money when they retire because they weren’t able to accumulate enough to keep up with inflation.
A reliable way to manage risk is to choose a strategy and stick with it. This is as much a matter of managing your emotions as picking an asset allocation strategy that’s in line with your investment profile. Learning as much as you can about different investments and strategies definitely helps. If you’re just getting started, read up on the basics like 401(k)s and Individual Retirement Accounts. If you’re closer to retirement, you may want to learn how you can shift your investment mix and convert your assets into income. Either way, enjoy the ride.