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Wealth Management, Investment & Wealth Management

Understanding Risk Tolerance

There are definite risks associated with investing. By understanding those risks and the impact they can have on your portfolio, you will be a more successful investor in the long run. Since there is inherent risk to all investments, you need to understand and periodically review the mix. By paying attention to your stocks, bonds, and cash investments and knowing their risk factors, you can create the risk/return that works best for your situation.

Use Your Knowledge of Risk to Your Advantage

Most people understand there is risk when investing. While many think of risk as simply losing money, there are other types of risk to be aware of as well. Only you can decide what is right for you when it comes to risk and your retirement portfolio. The potential returns associated with each category of investments need to be weighed according to their risk potential and how comfortable you are with that risk.

A Closer Look at Risk and Return

When it comes to risk, many people immediately think of the stock market. While risk in the short term may be high with stocks, the exact opposite is true when you look at stocks long term. They historically outperform bonds and cash investments. This type of risk/return might influence your allocation of investments. For anyone who is looking to stay invested for 10 years or longer, the stock market should be where you have the most money invested.

Bonds, which many people think of as safer than stocks, aren’t safe from risk. There’s the possibility the bond issuer might default on the interest and principal payments. This is called credit risk. There’s also the chance for interest rate risk, when rising interest rates cause the bond’s price to fall. Rising interest rates have historically determined the prices of bonds with more impact than the price of stocks.¹

Treasury bills have generally experienced a lower threshold of volatility than stocks or bonds, but they can still be influenced by risk of inflation, meaning the costs of everyday goods outpaces the treasury bill. For short term savings where you will need the money in 12 months or less, it may be more prudent to use a cash investment for this money, such as a money market account.

Diversify Your Portfolio

By diversifying your portfolio, you can choose the right mix of investments that suit your situation. By keeping an eye on your portfolio and having a mix of the right stocks, bonds, and cash investments you’re comfortable with, you can feel more comfortable with risk. Having a diversified portfolio won’t completely get rid of risk. However, it can help to open your portfolio to a broader range of benefits, while keeping risk lower than if you were investing in just one asset class. When you’ve done what you can to mitigate risk, it can help you to feel more confident about your investments by knowing you’ve done everything in your power to halt risk.

If you are still unsure about the right mix of stocks, bonds, and cash investments you should have, working with a financial advisor can help you to learn more. They can explain in detail the risk you might be putting your investments in and give you more input on the right mix of investments for your personal situation.

¹Source: SS&C Technologies, Inc. For the 30-year period ended December 31, 2019. Stocks are represented by the Standard & Poor's Composite Index of 500 Stocks, an unmanaged index that is generally considered representative of the U.S. stock market. Investing in stocks involves risks, including loss of principal. Bonds are represented by the Bloomberg Barclays U.S. Aggregate Bond index. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and are subject to availability and change in price. Cash is represented by the Bloomberg Barclays 3-Month Treasury Bills index. It is not possible to invest directly in an index. Government bonds and Treasury bills are guaranteed by the U.S. government as to the timely payment of principal and interest, and, if held to maturity, offer a fixed rate of return and fixed principal value. Past performance is not a guarantee of future performance.

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