Speaking of prosperity, in terms of market performance – as the Dow closes in on 20,000 – some of you may feel optimistic about the future; others not so much. Regardless of where we are headed, you must put aside events that cannot be controlled, and instead focus on what you can. The first step is to measure your personal “risk tolerance.”
Your risk tolerance is defined by how much volatility you are willing to assume in your investments over a specified period of time. In essence, the concept can be addressed by answering one simple question: “How much risk am I comfortable with in order to achieve my financial goals?” There really is no right or wrong response, but whatever you choose will become the foundation of your personalized investment strategy.
There are a number of factors to consider when assessing your risk tolerance, such as time until retirement, other income sources, and personal level of comfort in relation to volatility. This measurement is a critical component of all retirement plans because it helps financial advisors determine which products are best suited not only for your financial needs, but also for your temperament.
For example, let’s say 60-year-old Steven wants to diversify his portfolio to generate a steady return for his impending retirement. He believes that he only needs a modest amount of money to get by and does not want to concern himself with how the stock market is performing on a daily basis. Instead, Steven prefers to primarily protect his principal and experience little volatility. His risk tolerance would be considered “low.” Steven’s investments may never produce a large annual return on his investment, but a conservative approach may have helped to protect his nest egg from potential market downturns.
Steve’s son, Brian, is a 35-year-old aiming to build his retirement portfolio. Brian considers himself a savvy investor and is willing to take the risk necessary to earn a higher return on his investment. Unlike his father, Brian has a “high” risk tolerance.
Neither Steve nor Brian is an unusual case, but they perfectly illustrate the different objectives investors have. Steve will be more comfortable with a lower return while saving for retirement, as long as he can protect his principal. Brian understands that there may be times in which he could lose over 20% of his portfolio value in a particular year, but over the long-term, he is likely to experience a more substantial return.
So as we move into 2017, it may be necessary for you to reevaluate and, if necessary, adjust your risk tolerance level to match your temperament, investment time horizon, and long-term financial goals. Staring at the ticker every day may be captivating to some, and ulcer-inducing to others; therefore, you must decide just how much volatility you are willing to withstand on a weekly, monthly, and annual basis. After you have measured your risk tolerance, you may want to rebalance your mix of stocks, bonds, and cash (your asset allocation).
Additionally, analyze your investment costs, including advisor fees, commissions, and other overhead, such as expense ratios. It is also necessary to evaluate performance in comparison to appropriate benchmarks by position and portfolio.
Looking ahead, I believe that a few sectors offer some upside potential, including banks (VFH and FNCL) and defense (ITA, PPA, and XAR).
To protect against the downside, you may want to consider short term bonds (BSV), precious metals (GLTR), and gold (GLD and IAU).
On the fixed-income side, you may want to hedge against inflation with Treasury Inflated Protected Securities (TIPZ, TIP, and IPE). Note that inflation protected bonds do not protect against a Fed increase in interest rates.
Regardless of how you invest, I believe that the best approach to 2017 is to detach yourself from the daily incidents that you cannot control, and instead concentrate on things that will provide you with a more stable and contented lifestyle: connect with friends and family; work hard and be productive; and most of all – exercise regularly and eat well.
Your health may be the best investment you can ever make.
Test Your Knowledge
1.) Which of the following is not a factor that determines your level of risk tolerance?
- Time until retirement
- State of residence
- Personal level of comfort in relation to risk
2.) How much volatility an individual is willing to assume in their investments is defined by one’s _______. portfolio
- retirement plan
- investment plan made by an advisor
- risk tolerance
3.) If you would prefer to have little-to-no volatility, your risk tolerance would be considered?
4.) Someone with a low risk tolerance would prefer ________.
- not to be concerned with how the stock market is performing
- to diversify his/her portfolio to generate a more consistent return for retirement
- little-to-no volatility
- All of the above
5.) A person with a high-risk tolerance can expect to _________.
- see a steady, small, long-term gain with minimal chance for loss
- experience greater short-term gains and losses than someone with a low risk-tolerance portfolio
- see a guaranteed higher long-term rate of return
- All of the above
6.) If a person would prefer to sustain short-term market volatility to earn a higher return on investments, his/her risk tolerance would be considered ____________?
7.) What kind of risk tolerance would a person whose primary focus is to protect his/her nest egg from market pullback have?
- High risk tolerance
- Low risk tolerance
- Moderate risk tolerance
8.) Measuring one’s risk tolerance is a critical component of all retirement plans because it
- helps financial advisors determine your investment strategy
- helps advisors choose products that are best suited for your financial needs
- helps advisors choose products that are best suited for your temperament
- All of the above
See answers below