Few terms in personal finance areas important, or used as frequently, as "risk." Nevertheless, few terms are as imprecisely defined and implemented.
On a practical level, we can say that risk is the chance that your investment will provide lower returns than expected or even a loss of your entire investment. You are also probably concerned about the chance of not meeting your investment goals. After all, you are investing now so you can do something later (for example, pay for college or retire comfortably). Every investment carries some degree of risk, including the possible loss of principal, and there can be no guarantee that any investment strategy will be successful.
In general, the more risk you're willing to take on (whatever type and however defined), the higher your potential returns, as well as potential losses. This proposition is probably familiar and makes sense to most of us. We take on higher-risk, rather than lower-risk, investments with the prospect of receiving a higher return. That is the tradeoff. Your goal is to maximize returns without taking on an inappropriate level or type of risk, achieving the best risk-adjusted returns.
The ability to accurately identify your risk tolerance, and implement accordingly, is one of the most critical components in laying the foundation of a well-designed investment portfolio and understanding how it may impact your specific financial goals.
First, the concept refers to your personal desire to assume risk and your comfort level with doing so. This assumes that risk is relative to your own personality and feelings about taking chances. If you find that you can't sleep at night because you're worrying about your investments, you may have assumed too much risk. Second, your risk tolerance is affected by your financial ability to cope with the possibility of loss, which is often influenced by your age, stage in life, how soon you'll need the money, your investment objectives, and your financial goals.
Working together, we’ll use an Ameriprise tool that helps to make the process of identifying your risk tolerance more interactive and intuitive, using a series of historical market scenarios to illustrate the impact of risk on your portfolio, in both percentage and dollar terms.
From there, we’ll be able to better see where you are on the risk spectrum, ranging from conservative to aggressive, and how your portfolio risk will directly correlate to achieving your financial goals. It is important to also keep an open dialogue around investment gains and losses, risk and reward, over time.
By linking your risk tolerance to your investments, and then earmarking those investments towards specific and attainable goals, the hope is that you gain more confidence and a greater insight into the ups and downs of your portfolio and will be ready to stay the course with a more thoughtful investment plan.
Knowing your risk tolerance can help you avoid making costly mistakes. Maybe more importantly, clearly defining what risk means for you can help you stay the course with confidence as you plan and reach your financial goals through all market conditions.
Together, we can work to keep you on-track toward your financial goals.
Request a consultation to learn more.
Read more articles by John T Corcoran