If I asked you how much risk you are taking with the investments in your retirement plan, what would you say? My guess is nine out of ten people couldn’t answer that question in a meaningful way. Answers like “A lot,” “Just right,” or “not much,” may as well be “I have no clue.”
We typically think of risk levels in terms of “risk tolerance.” This is the appropriate portfolio risk that a person would be most comfortable taking with their investments. While investment advisors are required to assess your risk tolerance and you can measure it yourself on various internet sites, determining what risk you are comfortable with is more of an art than a science. It depends on the investment return you need to produce an acceptable retirement income and the asset allocation that will give you that return, and it is a delicate balance between emotions and financial reality.
When markets are rising, everyone is comfortable with their risk tolerance. I have known retirees who had their entire retirement portfolio in a handful of small company growth stocks—a powder keg of investment risk by any definition of risk. Yet they were entirely comfortable with that risk, because the stocks they were in “always went up.” Anyone with a stock that “always goes up” either hasn’t held the stock during a bear market or only looks at their brokerage statements once every five years.
To find out what comfort really means when it comes to risk tolerance, it helps to define “uncomfortable.” While risk tolerance tests will ask you how far must your portfolio drop before you freak out and sell, the best way to find this out is when markets are in a free fall. If you stay in the markets long enough to see them turn around and rise again, your risk tolerance was probably comfortable. If you sell out, it’s a pretty good indication your risk tolerance was not as great as you or your advisor thought. Unfortunately, selling out at a market bottom is a very costly way to find out the risk you had in your portfolio was “uncomfortable.”
If you have been investing for over 10 years, finding your risk tolerance may be simple.
- Think back to 2008-2009. Did you stay in the markets or get out?
- Look at old statements and find out what percentage of your investments was in equities (owning things) and what percentage was in fixed income investments (loaning money through CD’s, money markets, and bonds).
- Express this as a fraction with your equity percentage first and your bond percentage last. If you were 66% in equities and 34% in fixed income your asset allocation was 66/34.
- If you stayed in the markets, your allocation was probably “comfortable.” If you got out, it was certainly “uncomfortable.”
If your allocation was 70/30 and you stayed in the market, maintaining that allocation should serve you well. Maybe you could even increase the equity portion to 75/25 or 80/20 and still be comfortable.
Conversely, if your allocation was 70/30 and you sold out or reduced the percentage you held in equities, your allocation clearly offered an uncomfortably high level of risk. You will need to reduce the equities in your portfolio. This is especially true if you got back into your old allocation, or something even riskier, to “make up time.” You may well be taking too much risk and setting yourself up for failure all over again. You will need to reassess your risk tolerance as if you were a new investor. Next week I’ll suggest some ways you can do so.
Is the Cycle Over? Not Yet
Most Read IRIS Articles of the Week: September 17-21
The Market Isn’t Likely To Run Out Of Runway Anytime Soon
Cracking The Kindness Code: The Quest To Define Self-Compassion
How to Build Best-in-Class Websites with an Editorial Ethos
5 Non-Obvious Ways to Improve Your Sales
Know the Facts Before Considering an Annuity?
Use Strong Words to Use to Let Your Clients Know How Your Business Operates
54% of Americans Own a Life Insurance Policy, But One-Third Not Exactly Sure How It Works
3 No-Cost Creative Lead Generation Ideas You Can Implement Today
Explore Investment Insights14 hours ago
Is the Cycle Over? Not Yet
Equities2 days ago
Value Investors Must Remain Confident When Your Strategy Does Not Appear to Be Working
Operational Excellence2 days ago
How a $1.9B Firm Went From Losing Clients and Profits to Retaining and Growing
Leadership2 days ago
Woman: When Will We Be More Than Enough In Business?
Learn3 days ago
Tapping The Unmet Medical Needs Investment Opportunity
Public Relations3 days ago
ETFs Versus Mutual Funds: What’s the Difference?
Learn3 days ago
Bitcoin Will Lose 50% of Its Market Share to Ethereum in Five Years
Learn4 days ago
A Better Alternative For Diversified Alternatives