The investments you choose throughout your life will likely vary based on the degree of risk you are willing to assume and the average return you can expect. Generally, the rule of thumb is that the greater the risk assumed, the greater the potential return on that investment.
But finding the right balance between the return you desire and the amount of risk you can handle can be challenging. What was right for you yesterday might not be right for you today.
The last few years have made personal risk tolerance clearer for many. In bull markets, people generally seem to be more inclined to invest in higher-risk alternatives, perhaps understandably thinking they have a better chance for higher returns instead of big losses. And for some, the risk pays off.
But when a bull market turns into a bear – and the markets experience the kind of volatility that has almost become commonplace – those same high-risk investments could face substantial losses. “Risk tolerance” takes on a new meaning.
If your reaction to recent volatility is the primary reason for your new investing comfort level, you should also consider whether changing personal circumstances are a contributing factor. Just
as you should meet regularly with your advisor to reassess your objectives when major life events occur or you experience adjustments in your financial situation, it is important that you also modify your portfolio to match life changes and their influence on risk tolerance.
Since the willingness to take risks with investments usually increases with income, and then decreases over time as retirement draws near, where you are in your career and how much you are earning will also affect your tolerance. If you are just starting out in a career with little or no money saved as a cushion or safety net, you may be uncomfortable with high-risk investments because you simply cannot afford to have an investmentâ€™s value decrease. In this stage of life, many investors will choose low-risk investments, even though they offer lower return potential.
The reverse is generally true if you are in the middle stage of a career. You have enough years left to work if you need to recoup from possible losses, and with increased income, greater risk may be an acceptable trade-off for potentially higher returns.
If you are nearing the end of a career and approaching retirement, less risky investments are often the preferred choice. You probably have more savings accumulated
and less time to recoup from possible losses.
In some form or another, risk is inherent in all investments. But people invest because the rewards often outweigh the risks. No matter how the markets are performing – or where you are in life – a well-diversified portfolio generally helps to offset instability and can put you on a more comfortable path toward achieving your financial goals.
Contact a financial advisor to review the holdings in your portfolio. Working together, you can establish how much fluctuation in value you are comfortable with and how much you are willing or able to lose in hopes of greater returns. Then youâ€™ll adjust your portfolio accordingly, adding investments that may help you meet your goals – while staying within your comfort level.