It has been said, “With great risk often comes great reward.” That could not be truer in the world of investing.
The concept of risk and reward is one of the most important and fundamental theories to understand before making decisions on where to allocate your hard-earned dollars. I find that most people want to get the most return possible for the least amount of risk. Wouldn’t that be nice! In reality, risk cannot be eliminated when investing. Instead, it needs to be embraced.
What risks are involved with investing? There are many types, but I am going to touch only on short-term volatility of the stock market. In other words, the ups and downs that can sometimes feel like a rollercoaster. Risk tolerance is not static. It changes based on your situation and goals, timeline for needing the money and current market conditions, to name a few factors. If you have not assessed your risk tolerance or are due to review your existing level, here are some tips to help evaluate it.
• Recognize the differences between investors. Your situation is not the same as your neighbor or co-worker! When I meet with clients or prospective clients, it’s fun and interesting to see how different each situation is. So please do not compare yourself to others. There are varying degrees of risk but typically low (conservative), moderate and high (aggressive) are the most basic levels. A combination of these can also be used. Being aggressive with your investments means your main objective is growth and you’re willing to take on higher risk to achieve that. On the flip side, conservative investors favor preserving their original investments. Many investors fall in the middle of these extremes.
• Use online tools or questionnaires to help. You can even find one at our website, uncommoncentsinvesting.com. I advise using one that asks descriptive questions and uses “what if” hypothetical scenarios to dive deeper. Past behavior is a great benchmark to use while evaluating risk. The last time the market dropped significantly, how did you react?
• Do not rely on “rules of thumb” or conventional gauges relating to risk. For example, many financial outlets recommend that as you get closer to retirement you should become more conservative. Or have you heard of the Rule of 100? It states that an investor should hold a percentage of stocks (equities) equal to 100 minus his or her age. Those blanket recommendations are not always appropriate and could do more harm than good if you do not treat your situation as unique to you.
• Consult with a financial adviser before deciding where you fall on the risk spectrum. There are many angles to look at, even outside a questionnaire, before adhering to a strategy. Oftentimes I find that investors can accept more risk than they initially think.
I believe that once investors have been able to identify their current risk tolerance, they will be in a much better position to make investment decisions or changes to their portfolios. You are also likely to gain more confidence in the area of investing. Knowledge is power!
The views expressed represent the opinion of Uncommon Cents Investing. The views are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment. Investing in equity securities involves risks, including the potential loss of principal. While equities may offer the potential for greater long-term growth than most debt securities, they generally have higher volatility. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles, or from economic or political instability in other nations. Past performance is not indicative of future results. Investment advisory services offered through Uncommon Cents Investing, a registered investment adviser.
The Insiders: this article is sponsored by Uncommon Cents Investing.