Risk is a term that is tossed around during investment discussions. There are several different types of risk including longevity risk, credit risk, and inflation risk. Today’s topic is investment risk, which is essentially the risk that market conditions will cause you to lose money on your investment. In considering investment choices, it is important to consider where in the risk continuum your potential investment falls. An investment that would be considered as low-risk, such as a US Government Treasury Bill when held to maturity offers almost certain return of your investment but only a small amount of earnings. Conversely, a high-risk investment, such as shares of a start-up company, has no assurance that you will get your money back, but if it is successful, the return could be spectacular.
A well-designed portfolio should have a mix of investments. As our mothers told us: don’t put all our eggs in one basket. Clearly the quality and mix of investments is important, but it is equally important that the portfolio’s risk profile matches the investor’s individual risk.
Without a clear understanding of both the risk within the portfolio and the individual’s risk tolerance, you create the possibility of misunderstanding and disappointment. Over the last few years, the equity markets have been very strong, and have not had many prolonged down periods. Many investors who did not really understand their risk tolerance were happy to ride along. When the markets are booming, we are all happy to be aggressive. It wasn’t until 2018 when we started to see the return of volatile markets with fairly dramatic up and down days. This resulted in many investors realizing that they were not nearly as aggressive as they thought. Many sold and took losses just to move their money to a place of safety.
I can’t fault people for bailing out in the face of market losses. But it would have been avoidable if they had a portfolio that reflected their comfort level. True, they would have given up the upside potential of a big gain in the stock market, but they would have had a portfolio that reflected their expectations, and hopefully would have avoided having to realize a loss.
So, how do you figure the right risk level for you? I have added a link that you can follow to take a risk assessment. It is free, and there is no obligation. You can find the risk assessment here.