Risky Business: Understanding Your Risk Tolerance and Why it Matters

An important aspect of planning your investment portfolio is balancing your risk and payout potential to help you work toward your ideal financial future.

After all, you aren’t going to grow your wealth if you keep it hidden beneath your mattress in case of a rainy day, right? However, you don’t have to swing to the other extreme and rely exclusively on high-risk investments either.

Finding a happy medium will make you more comfortable with your portfolio and should help you feel in control of your future financial prospects. The first step to achieving this balance is finding your personal risk tolerance level.

So, what is risk? According to the Financial Industry Regulatory Authority (FINRA) “Risk is any uncertainty with respect to your investments that has the potential to negatively affect your financial welfare”. The uncertainty associated with future returns and the volatility of securities prices can cause investors to make emotionally-charged decisions and either sell too early or invest too conservatively (or too aggressively). Managing risk helps you stick to your investment plan and is key to good long-term investment results.

What is Risk Tolerance?

Investopedia defines risk tolerance as “the degree of variability in investment returns that an investor is willing to withstand”. Human beings are all risk tolerant to a certain degree, but everyone’s own level of risk tolerance varies. There are multiple factors that contribute to your personal level of risk tolerance, including:

  • What is time frame for achieving your investment goals?
  • How much have you already saved? Are you currently saving?
  • How much will you need to spend? How long do you need your funds to last?
  • Think about past experiences. (Here’s an easy test: If you find yourself constantly afraid of the next market crash, it may be the case that your balance of risky and less risky assets is not appropriate for you.)

In general, we tend to shy away from risk. In fact, we’re likely to be more than twice as concerned about avoiding loss than we are about achieving potential gains. This is known as loss aversion in behavioral finance.

Investing in the equity and bond markets is inherently risky. As an investor, you shouldn’t take more risk than you need to, are able to, or are comfortable with. Successful investing often means sticking with an investment plan that experiences both good times and bad times.

Balance Your Portfolio

Once you’re aware of your personal comfort zone and ideal level of risk tolerance, you are better prepared to build your portfolio. Sometimes, investors find that their portfolios are full of investments that are skewed toward more or less risk than they’re personally comfortable carrying.

If you suspect that your portfolio is imbalanced, talk to your advisor about how you can make adjustments to align your portfolio with your risk tolerance level. Here are some of the ways you can stay on top of the level of risk your portfolio contains:

  • Analyze investment risk and return relationships
  • Diversify your investments
  • Stay on top of economic trends and developments that can impact investments

Be Realistic

As you consider your risk tolerance, you do need to continue to approach your financial plan with a measure of realism. There is some unavoidable amount of risk that’s necessary to growing your investments to achieve your future financial goals.

If you have a particularly hard time coping with the requisite risk associated with building and managing your portfolio, talk to your financial advisor about how to find confidence and ways that you can minimize risks along the way. A trustworthy advisor should be able to guide you to the right investments for your lifestyle and can give you pointers on avoiding emotional investment decisions that could sidetrack your progress.

To learn more about how personalized financial advice can help you find the right balance in your investment portfolio email or call Jacob Sturgill today.

    Important Disclosures:
    There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

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