Risk tolerance can play a large part in determining the structure and composition of an individual’s investments and financial plan. As an investor, it’s important to know your risk tolerance for investments and be aware of circumstances that may affect it. Evaluating your risk tolerance regularly can help ensure your portfolio mix is still aligned with your current situation and future goals. Here are five considerations to make when assessing your risk profile:
- Understand how risk tolerance can affect a portfolio. Investors with conservative profiles are often individuals who have shorter investment horizons or fewer assets. These investors are usually matched to similarly risk-averse investment vehicles, such as bonds. Bonds generally offer lower returns in exchange for their relative safety. A portfolio heavily weighted in stocks is better suited to individuals with a high-risk tolerance. For example, younger investors who have time to bounce back from market fluctuations or investors with ample resources may utilize higher-risk investment options. Similarly, wealthy individuals who are willing to take on more risk for the potential of higher returns might explore IPOs, hedge funds, options and futures and other alternative investments. Most investors find a balance between risky and conservative portfolios. Risk tolerance is a spectrum, and you can find equilibrium in your portfolio as a whole by adjusting the riskiness of individual investments.
- Changes to your personal life. Big life events such as marriage, divorce, home ownership, parenthood or a job change can impact your risk tolerance. For example, having a baby may compel you to be more cautious about how you manage risk exposure because you’re responsible for an additional member of your family. On the other hand, making the last payment on your mortgage may give you more financial flexibility, and your risk tolerance may adjust accordingly.
- Changes to external circumstances. Your risk tolerance can be influenced by matters outside your personal sphere of influence. Stock market volatility, inflation and political events can contribute to your ease or discomfort with investment risk. When big external events occur, you may feel compelled to adjust your portfolio. Before doing so, keep two principles in mind: (1) It’s important for your investments to at least keep pace with the rise of inflation over time, overwise your portfolio will lose purchasing power. (2) Staying invested is one of the best ways to weather through market volatility.
- Consider your confidence with risk. Check your stress level when the market fluctuates. You may not have the stomach for market dips. You also may be less comfortable with risk if you have other reasons to avoid it: you’ve taken on more debt, had a reduction in your income, or have seen an increase in your cost-of-living expenses. Older investors may be most concerned with safeguarding principal and earning reliable, even if modest, returns. If you have noticed your discomfort with risk increase, speak with a financial advisor about potentially adjusting your portfolio mix.
- Progress towards goals. Younger investors can usually manage more risk because they have years ahead of them in which to make up for market downturns. A windfall or other improvement in your finances may allow you to take on more risk. Alternatively, drawing nearer to your goals – such as a child’s college enrollment or retirement – may mean you need to take on less risk to protect the money you need. (But remember: retirement investors should also consider that their nest eggs may need to last several decades).
Risk tolerance is not static. Like many aspects of your life, it can change over time. When circumstances shift, it’s wise to evaluate whether your investments are still appropriate. A financial advisor can help you assess the health of your holdings and make adjustments that match your risk tolerance.
Daniel P. Morrissey, CFP®, CFS®, CRPCTM, is a Private Wealth Advisor with Heartland Wealth Advisors a private wealth advisory practice of Ameriprise Financial Services, LLC. in Lebanon, Pennsylvania. He specializes in fee-based financial planning and asset management strategies and has been in practice for 40. To contact him, go to www.heartlandwealthadvisors.com or call (717) 270-6937 at 1536 Cornwall Road, Lebanon, PA 17042.
Certified Financial Planner Board of Standards, Inc. (CFP Board) owns the CFP® certification mark, the CERTIFIED FINANCIAL PLANNER™ certification mark, and the CFP® certification mark (with plaque design) logo in the United States, which it authorizes use of by individuals who successfully complete CFP Board’s initial and ongoing certification requirements.
Fixed Income
There are risks associated with fixed-income investments, including credit risk, interest rate risk, and prepayment and extension risk. In general, bond prices rise when interest rates fall and vice versa. This effect is usually more pronounced for longer term securities.
Stock Investment
Stock investments involve risk, including loss of principal. High-quality stocks may be appropriate for some investment strategies. Ensure that your investment objectives, time horizon and risk tolerance are aligned with investing in stocks, as they can lose value.
Alternative Investment
Alternative investments involve substantial risks and may be more volatile than traditional investments, making them more appropriate for investors with an above-average tolerance for risk.
Options
Options involve risk and are not appropriate for all investors. Before entering into any options transaction, clients must receive the document entitled Characteristics and Risks of Standardized Options.
Hedge Funds
An investment in a private fund involves a substantially more complicated set of risk factors than traditional investments in stocks or bonds, including the risks of using derivatives, leverage and short sales, which can magnify potential losses or gains. Restrictions exist on the ability to redeem units in a hedge fund. Private funds are speculative and involve a high degree of risk.
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