Balancing Financial Security And Investment Growth In Retirement Planning – Risk tolerance is one of the most important considerations – if not the most important – when building an investment portfolio or comprehensive financial plan. Risk tolerance is the investor’s ability to handle variability in portfolio returns, and it is in practice the ability and willingness to take investment risks.
Typically, older investors have a lower risk tolerance. Younger investors can generally accept more risk, given their longer time horizons. However, this is by no means a hard and fast rule. Each person’s risk tolerance should be assessed individually.
Balancing Financial Security And Investment Growth In Retirement Planning
Risk tolerance is your ability to handle portfolio volatility. In this context, it’s more about large negative moves because people can handle positive investment returns quite well.
Average Retirement Savings By Age
Risk tolerance can be influenced by a number of factors, including goals, age, portfolio confidence level, personal comfort and absolute net worth.
People who are saving for a big goal, like retirement or college, are likely to have a higher risk tolerance when they are further away from that goal. This is because investment returns tend to be reliably positive in the long term, while those returns can be volatile and unpredictable in the short term. If the broader market corrects or enters a bear market, long-term savers know they have a foothold before their goals arrive so they can avoid panic selling.
Conversely, people who have a short period of time to prepare for their stated goals, such as a down payment on a home or paying off a high-interest loan, will likely have a much lower risk tolerance. In this case, exiting the market may be the right move because market volatility can be unpredictable. They are especially unpleasant if you rely on the market to make large cash outlays.
Retirement With No Savings At 60 Years Old
On average, younger investors have a higher risk tolerance than older investors. Younger investors have many working years to earn, save and invest money, while pre-retirees and retirees may need their portfolios for day-to-day expenses. As a result, young investors have a higher ability to tolerate large negative portfolio changes. Older investors can be hit hard by bearish market shocks, which makes financial planning important if you’re into investing.
Although age is usually inversely related to risk tolerance, this is not always the case. Sometimes retirees continue to work with a fully funded pension plan, Social Security benefits and a strong personal savings account. These people may be able to tolerate more risk in their investment portfolio.
People who rely on their investments for living expenses will have a lower risk tolerance than those who only invest decades from now. The reason is simple: if you pull out of your growth assets when the market has fallen 20%, you are hindering your portfolio’s ability to grow by selling stocks at a discount.
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If you are living off your investments, consider having at least a few years of living expenses set aside in cash to avoid selling at an illegitimate time later.
Most investors simply—and understandably—don’t like to see their portfolios decline in value amid a stock market slump. If you’re someone who doesn’t want to see you lose weight, even if it means losing the potential to gain more in the long run, you may have a lower-than-average risk tolerance. While volatility is a normal part of investing, it’s entirely up to you to decide how much risk you’re comfortable taking.
It’s possible that as your net worth increases, regardless of your age, your willingness to take additional risks with your money decreases.
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For example, imagine you win a big lottery payout in your 30s. In theory, you can continue to try to grow that money well into your retirement, but you can choose to keep it. Even if your age indicates a high risk tolerance, your condition may cause your risk tolerance to be lower than it should be.
There are certainly gray areas within and between risk tolerance categories, but the main ones are broken down as follows:
People with a lower than average tolerance for investment risk. Typically, these investors will choose an asset allocation with a higher proportion of funds, money market funds, CDs, some fixed income securities and real assets.
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People who have a middle-of-the-road view of investment risk. Investors can choose the same or almost the same stocks for risky and safer assets. For example, someone with a moderate risk tolerance might have an asset allocation of 50% common stocks, 40% fixed income securities and 10% cash.
People who are willing and able to tolerate a higher level of risk. Typically, these investors have a high portfolio concentration of stocks and other volatile assets, potentially including speculative assets such as cryptocurrencies or NFTs. These investors tend to be on the younger side of the investment population, but this is not the rule.
Risk tolerance refers to an investor’s attitude towards investment risk, combining both their ability and willingness to absorb negative changes to the value of their portfolio. Your risk tolerance tends to be qualitative because there is a large amount of emotion involved in investing.
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On the other hand, risk capacity refers to your ability to withstand financial risk from a purely quantitative perspective. In other words, depending on your stage of life, you can only bear a certain amount of investment risk. If you take on too much investment risk as an early retiree, for example, you may not be able to cover your expenses if the market is in a downturn for any length of time.
Risk capacity can also be defined as the amount of risk required before your ability to achieve a stated goal is compromised. If your goal is to retire with a $1 million investment portfolio, but you keep all of your savings in cash, it’s difficult—if not impossible—to achieve your goal without adding to stock market risk. In this example, you need to determine the minimum level of acceptable risk that will still allow you to reach your $1 million goal.
It’s possible that your risk tolerance may not match your risk capacity, and that’s okay. Reducing your risk back to a level you are comfortable with is part of learning to invest and a sign of maturity. There’s no shame in knowing when you’ve had enough, even if it means a potentially lower net worth in the long run.
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Remember that risk tolerance is a moving target and one that most investors strive to determine on an ongoing basis. When developing the right risk tolerance, remember that this is a very individual concept. You need to take into account all the factors that affect your portfolio – taken as a whole – to determine the right level of risk for you.
As you continue to build your financial plan, keep risks at the forefront of your mind for a more peaceful experience. Finally, be sure to consider all financial and non-financial circumstances that may affect you in the future.
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Calculated by averaging the returns of all stock recommendations since the start of the Stock Advisor service in February 2002. Returns on 28/10/2023.
Calculated with time-weighted returns since 2002. Volatility profile based on calculated three-year lag standard deviation of service investment returns.
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