How Much Risk Is In Your Portfolio?
By Preston Rosamond
From a global pandemic to a contentious election season to social upheaval, it’s no surprise we have seen increased market volatility over the last year. News headlines will have you believe our world is spinning out of control, which can lead to panic and a number of other emotions. In times like these, often our first thoughts go to our finances. When it comes to our investments, income, threats to our lifestyle, our heightened worry likely tempts us to go into protective mode. After all, human beings are naturally averse to loss, and the pain of losing is more powerful than the potential to achieve gains. (1)
But here’s the irony: when we make emotional decisions and act irrationally in an attempt to avoid loss, we can lose even more. Just ask any investor who has sold stock when the market dropped and missed the recovery, only buying back in when the markets were high again.
What’s the solution? We know we need to invest to grow our money into a nest egg that will sustain us in the future, but how can you ensure you don’t take on too much risk?
What Is Risk?
In the financial world, risk tolerance is defined as a measure of one’s financial ability to withstand losses. While you can’t completely eliminate risk in your portfolio, you can absolutely ensure the amount of risk you take correlates with the level of potential reward for you to gain. It is more than possible to match your investments to your goals while still being able to sleep at night during market downturns.
Here’s the thing we need to remember when we’re tempted to get out of the market ASAP: some risks are avoidable; some are not. Avoidable risks are those which occur when your portfolio leans too heavily on stocks or bonds that have been unstable in the past or when your holdings are not diversified appropriately. For example, you may be putting too much of your company’s stock in your 401(k) plan. Or you may have an overabundance of overlapping U.S. stock mutual funds instead of being more globally diversified. Avoidable risks often occur when we underestimate risk and believe we can tolerate more than we actually can.
On the other hand, unavoidable risks are those that occur because our world is ever-changing, volatile, and we can’t predict everything. As much as we wish they weren’t, unavoidable risks are simply out of our control. This type of risk includes unfortunate events like geopolitical issues, global pandemics, and dramatic election seasons.
The third category of risk is often unseen, but it can impact your portfolio just as intensely as an obvious risk: the risk of being too conservative and not achieving your future goals as a result. By overestimating risk and trying to avoid loss at any cost, you could be unintentionally sacrificing your future dreams.
What Do I Do About Risk?
Unfortunately, it’s not as simple as telling your advisor you feel comfortable with “moderate” risk. Everyone has their own risk tolerance level, based on their age, life circumstances, and time horizon. It’s important to run through various scenarios with different risk levels to get an idea of how much loss you are comfortable with. If you start to panic and cringe, then you know you have hit or passed your limit. Both positive and negative emotions frequently cause investors to make unwise decisions. If you’re excited about the upward swing of the market, you might throw caution to the wind and invest more money than you normally would. On the flip side, fear might drive you to react and sell if you start losing money.
By anticipating your limit for risk, you can simulate situations that cause those emotions so you are prepared when they happen in real time. It’s a safeguard that will help keep you focused on the long term and trust in your strategy.
What’s Next?
Our goal at The Rosamond Financial Group is to help you discover your risk limits before you’re overcome with fear and tempted to panic. We’d love to chat with you, talk through your goals, and work toward your dreams while working within your personal risk level. Call my office at 830-798-9400 or email smrosamond@rosamondfinancialgroup.com to take the first step to becoming a fearless investor.
About Preston
Preston Rosamond is a financial advisor and the founder of The Rosamond Financial Group Wealth Management, LLC with nearly two decades of industry experience. He provides comprehensive wealth management and financial services to individuals, professionals, and families who enjoy simplicity and seek a professional to help them pursue their goals. Preston personally serves his clients with an individual touch and a sincere heart, and his servant’s attitude is evident from the moment you meet him. Learn more about Preston or start the conversation about your finances with him by emailing smrosamond@rosamondfinancialgroup.com or schedule a call with our online calendar.
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(1) https://www.behavioraleconomics.com/resources/mini-encyclopedia-of-be/loss-aversion/