Understanding the Role Risk Plays in Your Portfolio
Picture a scenario: You’ve got your emergency fund saved and now you’re investing a percentage of your savings in the stock market with the intention to save for retirement. In a market downturn, you lose a significant amount. How much is significant? Well, that depends on you and your relationship with money. 25% might be significant for one whereas another defines “significant” as 50% or more.
What do you do?
In this situation, some people are willing to stick it out, knowing that the majority of the times when the market dips, it also bounces back.
Some people are willing to stick it out for a time – but are starting to feel nervous.
And some people are ready to cash out all of their investments, sell everything in their portfolio, and switch to a cash-only retirement savings plan because losing money in the market is too much loss for them to bear.
Do any of these sound familiar?
If you find you fall into one of the “nervous” or “extra nervous” categories, you’re not alone! Many people are intimidated about starting to invest because they’re terrified of risk. This is a completely natural feeling that’s deeply rooted in our psyche. Investing involves taking risks with our money which is heavily associated with security. Nobody wants to feel as though they’re risking their security, safety or freedom.
That being said, investing has too many positive benefits to ignore. Investing is an excellent tool to grow your retirement savings, build your wealth, save for “big ticket” goals like home purchasing or funding your child’s college education, and so much more. So, what are we supposed to do? Taking the time to understand risk and your emotional response to risk is the first step you can take to embracing risk in your investment portfolio, and balancing your response to risk when you’re confronted with a turbulent market.
What Does Risk Mean?
Part of the reason we’re nervous about risk in our portfolio is that we’re not exactly sure what it means. Risk, inherently, sounds like a bad thing. “Risky” hobbies include bungee jumping and skydiving, or extreme sports where one wrong turn can result in catastrophic circumstances. Taking on a “risky” job might mean a lack of job security, low salary, or limited benefits. None of these things sound good!
However, when it comes to investing, risk is defined in a different way. Risk in investing can be viewed as the “possibility that a given investment will experience a loss over a given time period relative to the expected return over that same period of time”.
In short – risk is equated to uncertainty.
Risk in the world of investing is not synonymous with bad.
In some cases, “riskier” investments actually end up gaining the most return over a given period of time.
Managing Risk by Managing Time
When it comes to investing, it’s just not possible to fully avoid risk and earn returns that compound well and compensate for inflation. However, you can manage the amount of risk you take on by managing the timeline required to reach your savings goals. Time is, truly, the key to managing risk in your portfolio. If you’re able to map out a timeline to reach your goals, you’re better able to determine how much risk you’re able to take on in your investments. For example, if you’re a millennial saving for retirement, you have significantly more time for your investments to sit in the market and bounce back from any declines they endure than someone who is two years away from retirement.
In short, if you have more time to stay in the market and continue to adjust your investments as you get closer to needing the money from your investments, you’re able to initially take on more risk knowing that time is on your side. If you need your funds ASAP, you want to control your risk and likely take less on.
How Can An Investment Advisor Help?
Does the idea of balancing risk in your portfolio stress you out? Are you worried that you’ll sell immediately during a market downturn, even if it’s not in your best interest? Are you afraid you’ll make the wrong decision and drive yourself nuts until you decide? This is where working with an investment advisor can be incredibly helpful. You wouldn’t take on your own surgery without the expert help of a surgeon? Why do it with your money?
Your investment advisor’s sole job is to manage your portfolio, and because of the fiduciary responsibility Registered Investment Advisors are charged with, you can trust them to always be looking out for your best interest. Your Advisor will adjust it as necessary according to changes in the market, changes in your goals, and your ever-changing timeline for needing the funds you have invested. Your advisor can act as your sounding board when anxiety around risk sets in, or when you’re unsure if your financial goals are evolving to provide for your desired lifestyle. He or she will also be able to be more objective and able to help with focusing on your bigger life picture. It’s like having a CFO for your personal life.
Are you ready to get started investing?
Do you need to talk to someone about figuring out how much risk is right for you?