I dread this question…
When people learn about my years on Wall Street and writing investment newsletters, the next question is always the same…
I’ve had several careers, so I’ve seen this phenomenon from multiple angles.
When people find out I make my own wine… they ask for a bottle.
When I mention my medical career… they show me their rash or ask for my opinion about some injury they suffered.
And when they learn about my experience in finance… they always ask the same question: “What should I buy today?“
The reason I hate that question is there’s no good answer… How can I (or anyone) answer that question without knowing your goals or risk tolerance? Without the answers to those questions (and a dozen others), my response is almost irrelevant.
Unfortunately, many investors don’t actually understand their risk tolerance.
Here’s the thing… adding an appropriate amount of risk to your investments greatly improves your portfolio performance. Risk in the market is measured by something called volatility… The more volatile the investment, the more the price swings up and down.
That’s why stocks are much riskier than bonds or money market accounts. Their prices are more likely to bounce up and down. That means that you stand to make a lot more as the stock moves up, but you could also lose more as the stock falls.
If you’re taking on too much risk, your portfolio could take a big hit… especially if we go into a bear market.
If you’re new to investing, you may lack the confidence to take investment risks, too. Maybe it’s even kept you from investing at all and you’ve missed out on the incredible gains from the current bull market.
So today, I want you to assess your own risk tolerance with the guide below to get you started…
What’s Your Risk Tolerance?
Before we start, let’s review the common investment vehicles and where they fall on the risk spectrum:
As you can see, the least risky investments are cash and cash equivalents, like certificates of deposit. These are usually very stable investments, but ones that have low yields.
The riskiest, of course, are stocks. Stocks are the most volatile, but also produce the biggest gains.
So when considering how much to invest in each class, start with a few simple questions. Write down your answers and keep them for reference whenever you make future investing decisions. In fact, it’s a good idea to review your plan and risk level each year. Consider the following:
1. How close are you to retirement?
A popular theory is the “100 minus age” rule. Take your age, subtract it from 100, and that’s the percentage you should invest in stocks. That means a 35-year-old woman should have about 65% of her portfolio in stocks.
The idea is that the younger you are, the more time you have to recover from losses. So you want to take on more risk earlier. However, this is still a general guideline. Everyone needs to determine how comfortable they are with that kind of risk – that’s why we have two other questions…
2. What is your primary investing goal?
Are you looking to preserve your wealth, generate income, or grow your investments? These choices represent different levels of risk as well. For example, if you want to generate income, buying dividend-paying stocks will yield more than a typical savings bond, so you’ll want to account for that increase in risk.
One solution: Consider multiple accounts. We know a few folks not only have a conservative, “retirement only” account, but also a trading account where they take on more risk. This is a great way to potentially earn big gains without doing damage to your retirement nest egg.
3. How much you are you willing to lose in a one-year period?
Before investing in anything, figure out how much you are comfortable losing and write it down. If you don’t want to risk much, opt for less risky investments. Also, be disciplined about selling an investment if it falls by that amount.
Longtime readers know I prefer investments that let me sleep well at night. They offer a good mix of risk and returns.
But recently, one of my colleagues told me about a strategy that can help you earn thousands of dollars no matter where the stock market goes next.
Here’s to our health, wealth, and a great retirement,
Dr. David Eifrig and the Health & Wealth Bulletin Research Team
August 29, 2018