How much market fluctuation can you stomach? As the media focuses on the excitement of soaring markets, that may not feel like the question anyone is asking. However, it’s the right one. In today’s financial climate, we see people with low tolerance for risk, stretching for returns. And, as a result, they have more risk built into their portfolio than they know.
We are all conditioned through marketing and financial media that when it comes to investing, taking more risk brings more reward. The problem is that we begin to equate risk with reward. And when the downside arrives it brings with it shock and surprise. In reality, taking more risk may very well bring more financial upside, however, it also could bring more loss.
So, we present to you this very basic, yet clarifying, assertion: risk equals risk. Sometimes it results in a better gain, sometimes it results in a serious blow to your financial world, often times it results in something in between… but it ALWAYS represents a level of uncertainty.
When designing an investment plan, rather than starting from the viewpoint of how much growth you want, it’s critical to determine what your true comfort level is with risk. One size does not fit all, and each individual’s tolerance for risk is personal. And folks need to accept that investing within their risk profile will often mean limiting upside.
To be clear, this isn’t about whether one investment is superior to another or whether high-risk investments are good or bad. This isn’t about advocating for a certain type of investment. It’s about really breaking down the reality of investment – what the downside will mean for you and your financial life. And coming to terms with the reality that risk cuts both ways… one can’t both stretch for returns and then be surprised by a loss.
The Entrepreneur as a Risk Taker
Entrepreneurs are the ultimate risk takers. After all, in most cases, they’ve taken enormous risk to their financial livelihood to strike out on their own with their talents and ideas. When we talk to business owners, we try to make a distinction between their active, wealth creation (through their business ventures) versus passive investing (e.g. retirement accounts) which may be more appropriately geared toward preserving the wealth they have created.
Equally important to point out – two business owners may be in the exact same position financially, however, (because risk tolerance is so personal) their investment strategy may be completely different.
Understanding What Risk Really Means For You
It’s critical to have the clearest possible understanding of what risk means to you personally. Often when speaking with an investor they will say “I’m fine if my account fluctuates by x%”, but when we calculate the actual dollar amount that x% represents, they are surprised. When discussing risk, percentages can be an ethereal concept – not always easy to connect to the actual dollars it represents.
So, investors should have a very clear picture of what the probable outcomes might be, in dollar amounts, when making investment decisions. Letting their risk tolerance level dictate the amount of risk they are comfortable accepting, and then be willing to accept that it will likely restrict the upside.
Bottom line: if you aren’t comfortable taking a big loss, then (rather than stretching for returns) a more appropriate approach would be to accept the more modest returns generated by a strategy that fits your risk level.
If this has you wondering about your risk tolerance or if you’d just like to explore the topic further, we'd love to chat.