The Basics: Your Risk Tolerance

PART 1 of 4: THE BASICS
As we said last week, it is time to MAN UP and begin adding to your nest egg.   I promised that I would help you look at how to structure your portfolio for long-term growth.  Let’s jump in one step at a time!

There are a couple words that you should know. Do not be intimidated by them but get to know them because they are used regularly when talking about investments.  Remember, you are taking charge of your financial future and you must start educating yourself if you haven’t already.  Every one of us must take this education leap if we are to feel and be secure when it comes to money.   Money weighs on everyone’s mind, even if you have a lot of it – I promise.   No time like the present to start learning!

If you are experienced with the items below, take a minute and send this knowledge to someone who may not be.  In a couple of weeks, I will start reviewing different investment ideas for those who are ready for the good stuff…research.

Risk tolerance – the amount of swing or variability in your investment returns.   The more aggressive risk investor is ok with investments that have potentially large swings in return.  They are willing to gamble for the larger return possibility.  Aggressive portfolios typically have mostly stocks and possibly some complex investments.  A moderate investor likes more average like returns that are dependable and would likely have half or slightly more than half their portfolio in stocks and the rest in bonds.  A lower risk conservative investor would prefer minimal swings in investment returns, and investments that are very stable.  This investor would likely have less than 40% of the portfolio in stocks.

Capital markets – financial markets where equity or debt securities are bought and sold.

Asset Allocation – an investment strategy that will mix different risk and return investments to suit an investment risk level, goal and time frame.

Portfolio – another name for an investment strategy or asset allocation; can be made of multiple accounts.

Diversification – spreading your money among different types of investments each with different characteristics.   Not putting all your eggs in one basket.

Cyclical – financial markets move in reoccurring cycles and depend on many factors.  Some of which include: business profitability, economic growth, politics and individual spending patterns.

Stocks – shares of a business which are sold as a means of raising money for that business or corporation.

Bonds – debts that the issuer, or company, promises to pay the holder interest plus the principal over a specified time.   Bonds are rated for riskiness based on the strength of the company’s financials and the length of time the debt is issued.  Bonds can be used to decrease the overall risk of a total portfolio.

ETF – also known as an Exchange Traded Fund.  This investment is traded like a stock but is a basket of securities to represent a market index rather than shares of 1 company.  The basket can be made of stocks, bonds, commodities or a combination thereof. Many ETFs are low cost.

Mutual Fund – a professionally managed investment fund that pools money from many investors to purchase securities. Mutual funds have advantages and disadvantages compared to direct investing in individual securities. The primary advantages of mutual funds are that they provide a higher level of diversification, they provide liquidity, and they are managed by professional money managers. On the negative side, investors in a mutual fund must pay various fees and expenses.

 What is RISK to you?
Know your risk tolerance and how much time you have to save (maybe that’s retirement for you or maybe that’s your children’s education, as examples). There are many risk questionnaires available out there on the web for you to use. It is important for you to know how much risk you can handle because the capital markets are cyclical. Over the long-term, you are likely to have negative returns from time to time and they may last many months. You should know how you would feel and how you would respond during those periods. Once you understand your risk you can then determine how to asset allocate, or use a mix of investment types within your portfolio. Your risk tolerance may change over time, and that is ok. Just know this relationship with your financial future is a give and take. If you have a less risky tolerance you may have to commit to saving more, and if you have a riskier tolerance you may initially have to save less but if your portfolio, or account, loses a lot of money you may have to commit to saving more for some period of time.

Take time and really digest this idea of risk and really understand how you would feel if the market crashed or accelerated dramatically. How would you react?   Would you be calm and make small adjustments, would you cry and panic or would you stay invested as you were?   Your risk appetite may change the more you educate yourself and build the confidence to take charge of your investments.  Get comfortable with how you, as an individual, feel and then move on to my next post, about asset allocation. Keep learning, knowledge is key!

 

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