Overestimating Your Tolerance for Risk.
In the final part of this 3-part series, we sat down with Kyle Dana, AG Financial Solutions’ senior vice president of Retirement and Investments, to hear his insights and answers to common questions regarding investing.
Q: In the first part of this series, you shared about the role of emotions in relation to investing. What else do people need to consider when looking at investment options?
A: Risk is a general area investors need to know more about—both understanding what risk is, as well as understanding their personal tolerance level for it. Risk is defined as exposure to the chance of loss. Risk is not about how high your possible returns would be, but rather about understanding your potential for loss as well as gain. It is important to understand the relationship between risk and reward; the bigger the possible reward, the larger the risk.
It’s easy for investors to get too focused on returns and lose sight of the involved risk. Remember that if your investment has the potential to make 20% in the market, it also may have the potential to lose 20% or more. The Great Recession of 2008-2009 had two significant positives: 1) it reminded us that the market is unpredictable, and 2) it provided buying opportunities. The irony is that because investors had not properly understood their own risk, the Great Recession left them scared and paralyzed.
Q: How should an investor determine how much risk they can handle?
A: You’ve heard the quote, “you’re your own worst enemy.” This can be especially true when it comes to investment portfolios and not making decisions based on your risk tolerance. This quiz is a generic example of the variety of quizzes available online to help investors identify their risk level.
Determining your risk tolerance is not a one-time-only event. Your risk tolerance level in your 20s may not be the same in your 40s. Your tolerance for risk can shift due to age, changes in family status, income, etc., and therefore should be assessed periodically.
At the end of the day, you have to know your financial objectives and understand how much risk you’re willing to take. Focus on developing a diversified portfolio that matches your risk tolerance level.
Q: You mentioned knowing when risk is and is not okay. Can you expand on that?
A: The industry often determines how much risk you could take based on time. For example, the further away from retirement you are, the more risk they would suggest you take. And conversely, the closer to retirement you are, the less risk they may suggest you take. While this is an acceptable generality, in my opinion, investment decisions should be based more on personality. For instance, the industry may advise an investor in their 30s to take more risk. But if that 30-year-old has a personality that is more risk-averse, they would most likely panic and overreact to market downturns which could cause more harm to their portfolio than if they had invested according to their personality (less risk).
If you are nearing retirement age, I would urge that you be very careful with risk. Work with a trusted advisor when thinking about reallocating your investments. A market correction could be devastating at a time when you can least afford a loss. You simply may not have adequate time to allow your investments to recover.
For those looking for less-risk, a popular investment option within the AG 403(b) is the fixed rate MBA Income Fund, with a stable rate of return since inception more than 60 years ago. As of July 31, 2017, the annualized return since inception is 6.65%.
Ultimately, investor choices can do the most damage to a portfolio. By properly evaluating your risk tolerance, you can reduce the likelihood of making poor investment decisions.
If you’re an AG 403(b) participant, familiarize yourself with the investment options available within the plan. From the MBA Income Fund to the multiple stock strategies, there are investment options within the plan for all risk tolerance levels.
This information is not legal, financial, or tax advice. Information is from sources deemed reliable. Information is subject to error, omission, withdrawal, or change. Contact your own legal, financial, or tax advisor before taking any action.