Are you afraid of market risk? The prospect of losing money can be very scary, but it can also be hard to resist the possibility of making a profit. Determining your risk tolerance is the first step in building a well-balanced portfolio.
Discuss your risk management strategies with a competent financial planner to make the most effective investment decisions.
As a financial planner, I’m often asked what the best investment is. My answer takes the form of another question: what are your goals? Every investment instrument has its own plusses and minuses. I see my job as a matchmaker, pairing the investor with an appropriate investment.
Traditionally, stocks are considered to be aggressive investments and bonds are deemed more conservative. However, despite your personal risk tolerance, there may be times when even the most risk-averse individual should invest some money in stocks. This is because historically stocks, over the long term, have shown continuous growth.
The Real Risk
Although no one likes losing money, simply avoiding an investment because of the possibility of loss may not be wise. While there is a certain truth in the adage “a bird in the hand is worth more than two in the bush,” the notion that now is better than tomorrow may not hold true for retirement planning. Take, for example, the worker who diligently saves his entire working career and invests in conservative investments with below-inflation returns. Although this investor avoided risk and the potential of losing his money, his accumulated nest egg may not be sufficient to last throughout retirement.
The risk of not accumulating enough money may be greater than the risk of losing money in poorly performing investments. This is because while a worker is in the accumulation stage, time (and current earnings) works to his advantage: you can re-allocate remaining assets and increase savings. But, as you live longer and have increasing bills to pay, the risk of outliving your money increases.
While it may seem prudent to err on the side of caution, don’t be too cautious in determining asset allocation. After all, every day we risk falling when climbing out of bed and risk a car accident when turning onto the highway. However, there are mechanisms for managing risks before they become debilitating (step carefully before climbing out of bed and drive carefully.) Similarly, there are mechanisms for managing the risks of investing.
Speak with your financial planner about determining the best risk-management solution for you. Only you can decide which is scarier: the risk of losing money today or the risk of running out of money tomorrow. Do the potential profits of a diversified stock portfolio outweigh the risks? Your investment advisor can help you find the proper match between your risk tolerance and appropriate investments.
For more advice on the issue of risk in investing, read Uncertainty is a Necessary Part of Your Personal Financial Planning Process.
Disclaimer: This article is for educational purposes and is not a substitute for investment advice that takes into account each individual’s special position and needs. Past performance is no guarantee of future returns.