To be a successful saver, you’ll need to get your risk profile right.
Whether you’re new to investing or have had a lifetime of stock market experience, there’s one thing that can derail a financial plan: the fear of losing money. History is littered with stories of people who have created plans, only to tear them up after a recession or some unexpected drop in the market.
Investing isn’t just about picking securities that will make money. It’s about choosing investments that line up with your risk tolerance.
Investing isn’t just about picking securities that will make you money. It’s also about choosing investments that line up with your risk tolerance. If you’re a conservative investor but hold 80 percent of your money in equities, then there’s no question you’ll panic when the market falls. If you’re a more adventurous investor but hold most of your money in bonds, then you’ll wonder why you haven’t made the returns you were expecting.
Determining your risk tolerance can be difficult, since you often can’t gauge it until the market corrects. When you do get it right, though, investing will be that much easier. You may still feel a little pain when the market falls, but you’ll be far more comfortable and confident that your portfolio will bounce back.
We spoke to Andrew Beer, Manager of Strategic Investment Planning at Investors Group, about how people can figure out how much investment risk they should take on.
CFP, CIM, is Manager of Strategic Investment Planning at Investors Group
FIRST OF ALL, WHAT EXACTLY IS INVESTMENT RISK?
When it comes down to it, it’s the risk that you won’t make any money or won’t make enough. There are different ways of looking at risk. For instance, there’s time-horizon risk, where you need to get the right mix for your age. There’s default risk with bonds, or diversification risk where you could be too concentrated in one country or asset class. But it’s really all about the risk of not having your money grow.
WHERE DOES DETERMINING ONE’S RISK PROFILE BEGIN?
It starts with goals. You need to know what you’re trying to achieve before you can figure out your asset mix. A lot of people can have different risk profiles for different objectives. Maybe you have something earmarked for an upcoming purchase. Those funds would be invested more conservatively than if you’re young and investing for retirement.
WHY DO PEOPLE GET THEIR INVESTMENT RISK WRONG SO OFTEN?
Most people start investing in a bull market and they get caught up with the spectacular gains that the stock market is producing. They feel fairly comfortable, so many don’t take the time to fully understand market risk. And it’s hard to understand it until you actually experience it, unfortunately.
It’s very common for people to assume they’re riskier than they really are. It’s only when they go through an episode of market volatility that they realize they weren’t really as risk-tolerant as they thought.
CAN YOU FIGURE OUT YOUR RISK BEFORE IT’S TOO LATE?
Yes. Some people know they can absorb, say, a 20-percent loss in a year and feel comfortable with that knowledge. They know that markets recover and move to higher ground.
HOW CAN SOMEONE FIGURE OUT THEIR RISK TOLERANCE?
A questionnaire is great for that. There are usually two parts to it. The first is time horizon. Do you have a short-term horizon or long-term? The larger part, though, is more geared toward fleshing out your true comfort level with risk. One way this is done is by asking you how much you’re comfortable losing. Rather than saying 10 percent or 15 percent, it’s better to talk in dollar terms. If you have X amount invested, will you be comfortable losing X amount? That brings it home for people.
WHAT’S THE ADVISOR’S ROLE IN THIS PROCESS?
You’d sit down with the advisor and go through the questionnaire. At Investors Group, we have a very thorough one that most people use with their clients. But be sure you actually go through it with your advisor rather than doing it on your own. If you do it yourself, you may not fully understand or appreciate certain questions. If you can establish the proper expectations from day one, then you won’t run into problems when volatility is introduced.