As a financial advisor, I am often asked the question, “am I taking on too much risk in my portfolio?”
Clients often want to know if they should take the risk and if so how much risk is too much?
A customer recently came into my office and ask me to cash out all the money in her retirement account and put it into a money market fund.
When I asked why she wanted to make this change, she said it was because her mom told her that the market was too volatile, and she should cash out.
This is probably the one statement from clients that makes me cringe; it’s like the sound of nails scraping down a chalkboard.
Risk is a personal financial decision
Why? Because the truth is there is no correct answer. It all depends on your personal investor profile. The investment strategy that works for your co-worker, neighbor or family may not be the right strategy for you. You are different people with different financial goals and a different risk tolerance.
The correct level of risk that investors should take depends on their personal financial situation, how much fluctuation they are willing to take for a potential rate of return as well as how long they want to invest.
Ask yourself these three questions before you invest
What is my investor profile?
Your investor profile is your personal investment strategy. After answering a series of questions with your financial advisor you can determine if you are a conservative, balanced or aggressive investor. My client is a stable investor; this means she should have approximately a 60/40 split between fixed income and equity in her portfolio. Based on her comfort level with risk there is no reason for her to be in an ultra-conservative investment such as money market funds.
Will I sleep at night with this risk?
Determining your investor profile is the first step in deciding your comfort level with risk. Even though your answers may determine you are a balanced investor 60 percent in equity may keep you up at night. If this is the case, you may want to talk with your financial advisor and decide if you should lower your level of risk. You want to take a bit less risk with a 70/30 split between fixed income and equity.
How long do I want to invest?
A general investing rule of thumb is the longer you invest, the more risk you can take. Of course, this depends on the investor’s profile as well as your comfort level with risk. If you are investing for the long term you can take more risk in your portfolio because you have a longer period for the market to recover and hopefully recover your losses. Short-term market fluctuations may not provide the time you need to improve the value of your portfolio if you need to use the money.
Before making any investment decisions speak with your financial advisor to determine your comfort level with risk.