Growing investments to a value that’s sufficient enough for you to retire is a common goal. Funding the kids’ college fund so that it’s large enough when their time comes around is another worthy one.
Whatever the goal with investing, achieving it is a critical factor in the equation. However, one area that is often overlooked is the subject of risk tolerance, which is why we cover it here today.
What Is Risk Tolerance?
With an investment portfolio, it will experience a flow of ups and downs even when it’s well-diversified. Investing any percentage of investment capital into the stock market can see whipsaw movements where it’s up 30 percent one year and down 12 percent the next.
Risk tolerance and risk governance relate to where you sit in your acceptance of these movements in value. While the portfolio value is relatively small, the percentage change might be more significant than the dollar value. However, as the portfolio grows, the value of your investments may move alarmingly positively or negatively in a given day, week, or month. How accepting will you be of that?
How To Balance The Risk Of A Portfolio
The volatility of your investments means they can adjust in value considerably in any given year. Bad news or a tough economy can send the stock market tumbling. Because a single year’s returns are never predictable, investors must be prepared for what can happen.
With a stock market index like the S&P 500 index, it may rise or fall up to 20% in a typical year. Yet, smaller movements are possible too. Nevertheless, a sharp decline could see the market tumbling 50% or even more in some situations. And recovery may require several years to return to the previous valuation too.
To prepare for this, investors often use a balanced approach with a mix of stocks and bonds to settle the waters. Adding bonds to the portfolio usually reduces its overall volatility. By using a blended approach with stocks, bonds, and possibly other asset classes too, it’s possible to reduce the swings in portfolio value that may otherwise give you an upset stomach.
What If You Need Advice Or Help To Manage Your Investment Risk?
Holding a firm and not selling out when the stock market is down 50% and your balanced portfolio is reduced by 30% (you had some cash and bonds in there too) is hard. Emotionally, everything is screaming to sell, sell, sell! Certainly, this lets you know that your risk tolerance was lower than you thought. It’s also suggesting that you might do better with a registered investment adviser managing your portfolio.
An advisor can talk you through a steep market decline, which helps to avoid knee-jerk reactions causing you to sell out near the bottom. Doing so locks in your losses and doesn’t let your investments rebound either. To learn what advisory services are available from an investment advisor, check out affiancefinancial.com.
For people who feel ill-equipped to handle their investments or don’t know how to assess their true risk tolerance, getting sound advice and management services is often the answer. It removes considerable uncertainty about whether it’s being done right and avoids panic selling too.