One of the most important skills investors can develop is the ability to determine how much risk one is willing to take. The old adage “with no risk there is no reward” remains true for investors but being conscious of how much risk you’re taking – and when in your lifetime you’re taking it – is critically important to having success as an investor. Taking too much or little risk, at the wrong time in your life, can spell disaster for your portfolio.

How Do I Determine My Tolerance?
Understanding the amount of risk you’re willing to assume takes some serious and honest self-reflection. First and foremost: please stop listening to the success (or failure) others are having when investing. Much like most forms of social media, our friends and family (or strangers on the internet) tend to highlight their successes – less so their failures. This leaves most of us with a feeling of being behind or at least missing out on something. If this feeling persists, it can lead to some unhealthy risk taking in order to “catch up”.

Tune out the noise. What matters is how you are personally saving and investing, not what anyone else is doing.

Now it is time to dive deep and figure out how much risk you’re actually willing to take. The greater risk you’re willing to take the greater reward you may receive – but also the greater possibility for loss. A simple exercise is this: if you had a $100 to invest, would you be comfortable losing all $100 if it meant you might make $100 profit? Or would you be more willing to lose $50 or $25, if it meant you’d earn $50 or $25 in profit? Keep in mind that the likelihood of hitting on the first bet is much less certain than the second or third.

Translate the amount of money you’d be willing to lose out of that $100 to a percentage. If you’re comfortable losing $50, you’re willing to risk 50%. Put differently: on a scale of 1 to 10, you’re a 5. This is an oversimplified way of determining risk – another route is to take an online risk tolerance quiz from a reputable source like Lincoln Financial Advisors.

A few rules of thumb: If you’re young, you can afford to take more risk than those further on in life – you have much more time to come back from the losses. If you’re in retirement you can’t afford to take zero risk. With many of us leading longer lives in retirement, we often must find a way to make our money stretch 20 years or more – which means we need to keep growing your money or inflation will erode our purchasing power. And for those of us somewhere in between it’s important to stay on top of how much risk we’re taking – unfortunately its far too easy to let the years go by without adjusting our investments and starting to take less risk as we get closer to retirement.

What do I do with this information?
Once we know our tolerance for risk, our next step is to make sure our portfolio allocation aligns with that tolerance. Generally speaking, stock investments are riskier than bond investments – although neither is free of risk entirely. History shows the potential for gains is larger with stocks, but also the potential for loss. The variation is higher than it is with bonds. Using our scale of 1 to 10 from above, with 1 representing little risk and 10 being the most risk you could take, a score of 5 could translate to a portfolio of 50% stocks and 50% other (bonds, real estate, money markets/guaranteed sub accounts, etc). A 6 or 7 out of ten would allocate 60% or 70% towards stocks. This is a general rule of thumb, not specific advise – but we need to start somewhere.

Is there a shortcut?
I can hear it now – “Andrew, this is great, but who has time for this? Isn’t there an easier way? Fortunately, there is. Target Date Retirement funds* do the heavy lifting for you. These funds are based on your age and timeline to projected retirement to determine the amount of risk to take for you. Predictably, these funds will allocate much more risk to someone retiring in 2060 than someone retiring in 2030. What’s great about these target date funds is that they automatically become more conservative for you over time, therefore managing your risk exposure for you. While I encourage you to remain actively involved in your retirement plan investments, target date funds can be a good shortcut.

It can be hard for us to determine how much risk we’re willing to take until we’re faced with actual losses. That’s why it’s so important to do the hard work now, to be honest and seriously consider how much risk you’re actually willing to take. Here is where the value of a financial professional can really shine: though you may have a good idea of your personal risk tolerance, financial professionals can challenge some of you assumptions and point out relevant factors to help you arrive at a more concise answer, which you can then implement throughout your portfolio. If you’re struggling with determining your own tolerance for risk, I urge you to reach out and schedule a time with us or your own financial professional.

For more information contact:

Andrew Thompson
The Capital Group
608-268-5100
andrew.thompson2@LFG.com
Meet with Andrew

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*A time horizon as an investment objective at an approximate date when an investor plans to start withdrawing their money. Such portfolios generally have more equity securities early and more income securities later to reduce risk, volatility and return potential moving toward the target date. The principal will fluctuate and is not guaranteed at any time including the target date.

Andrew Thompson and Andrew Seaborg are registered representatives of Lincoln Financial Advisors Corp. Securities and investment advisory services offered through Lincoln Financial Advisors Corp., a broker/dealer (member SIPC) and registered investment advisor. Insurance offered through Lincoln affiliates and other fine companies.