The goal of investing is simple: to grow your assets. Yet investing involves risk, which means you may end up with less than you started with. Without risk, however, there’s no potential for reward. That’s the investor’s quandary—how much risk is tolerable in the quest to meet your financial goals? As you review your investing strategy for the upcoming year, consider how your risk tolerance may be affecting your portfolio.
Personalities and life experiences shape risk tolerance
Your comfort level with risk has roots in your personality and life circumstances. For example, growing up in a financially strained household or living through a period of economic difficulty can dampen your enthusiasm for investment risk. Whether you are generally optimistic or pessimistic can also influence how much risk you are willing to take. On the other hand, there are the thrill seekers who are drawn to the potential for large gains. Generational influences can also shape whether you lean toward financial restraint or have a more carefree attitude about money. For example, men tend to be more likely to embrace risk, while women may be more cautious.
A 2015 Ameriprise study, Financial Risks & Investor Attitudes, found that many U.S. investors allow their feelings about risk to influence their investment behavior in ways that are detrimental to their financial goals. Three risk profiles illustrate how attitudes can trip up the best investment intentions.
1. Avoiding risk at all costs
For example: A retiree receives a monthly income from Social Security and a generous pension. His combined income has been sufficient to meet expenses and his lifestyle, so he hasn’t had to dip into his savings. Despite his financial comfort, he is only comfortable investing in assets that provide a fixed return or allow him to cash out quickly.
In this example, the retiree represents a risk-adverse investor. He has the financial leeway to invest in higher yield investments, which offer greater growth potential, yet he chooses a more conservative path. Does this sound like you? If so, your dislike of risk may be hampering your ability to capitalize from a more diversified portfolio. At the minimum, make sure your investments are keeping up with inflation. Talk to your financial advisor for reassurance if you suspect you can handle more investment risk.
2. Overreacting to market changes
For example: A working couple with two teenagers contributes the maximum amount to their employer-sponsored retirement plans, with the intention of retiring in 15 to 20 years. They’ve taken care to purchase sufficient insurance to protect their family. After the last market downturn, they redistributed their portfolios to hold only low-risk investments.
Are you like this couple, quick to react to external events without considering the long-term? A balanced portfolio can help you weather bumps in the market that tend to even out over time. Your financial advisor can help you employ a consistent strategy that periodically rebalances your assets to align to your investment goals and time horizon.
3. Investing beyond your capacity to withstand losses
For example: A middle-aged single architect earns a good living but has difficulty setting aside funds for the future. She enjoys researching and investing in startup ventures in the technology sector. She admits to investing in long shots, hoping to hit the jackpot.
Investing in high-risk investments when you have limited assets or a short time horizon is asking for trouble. If you are tempted to take bigger risks than your portfolio can withstand, enlist a financial professional to help you maintain a more disciplined approach to investing.
Find Balance and Opportunity in Risk
If you relate to any of the three scenarios above, your risk tolerance may be preventing you from reaching your investment goals. An experienced financial advisor can help you arrive at investment decisions based on financial principles rather than emotions. Together you can factor in your assets, time horizon and capacity to manage losses as you select investments with the best chance of generating optimal returns.
William “Drew” Watson CFP® is a Financial Advisor and Private Wealth Advisor with Ameriprise Financial Services, Inc. in Owensboro, KY. He specializes in fee-based financial planning and asset management strategies and has been in practice for 20 years. To contact us by phone, please call 270-684-8424, or mail to 111 West 3rd St., Owensboro, KY 42303. You may also visit our website at www.williamawatson.com.).