In order to build a financial plan that’s customized to your goals, it requires assessing a wide range of factors. Maybe one of the most important for determining your investment strategy is how well you handle risk.
Understanding your risk tolerance is absolutely necessary to ensure you’re going to be comfortable no matter what’s happening in the market. If you’re taking on too much risk, you might lose sleep at night worrying about your money. And if you don’t have enough risk in your portfolio, there’s a chance your returns aren’t as healthy as they need to be.
The thing we see too often when it comes to risk is that most people either don’t know how much risk they are carrying or they don’t have a great grasp on what their risk could mean to their bottom line.
Let’s start with that first point. If you haven’t worked closely with an advisor or you’ve just picked out investments for your retirement accounts on your own, there’s a good chance you don’t truly understand what’s in your portfolio. Whether it be mutual funds or individual stocks, you want to make sure you know what and why you’ve chosen the investments you have.
Even if you know what you own in your portfolio, how well do you know what that risk could mean to your account value when the market crashes? And it’s best to look at the market swings in terms of dollars rather than percentages. Think about it like this. If you have $1 million in your account and your risk could create the possibility for a 20% loss, does that sound a little more manageable than losing $200,000? Most people would say yes.
That brings us to another point that’s important to remember about risk tolerance. Very few people worry about their exposure to risk during a bull market. We always want to make sure you know what the potential range for your gains and losses might look like based on different allocations. Once you see it laid out on paper with values attached, then you can truly assess your risk tolerance.
One last thing we want to highlight about risk is that your level of risk should change as you age. More often than not, it’s a bad idea to be investing in your 60s the same way you were investing in your 30s. As you approach retirement, the goals shift away from accumulation and more toward protecting what you’ve built. Just like everything else in your overall retirement plan, you want to be evaluating your positions on a consistent basis with an advisor.
Risk tolerance might not be the only determining factor in how you invest, but it’s a key part of building out a plan so that you have confidence and calm about your future.