subject: Make Your Investments Consistent With Your Risk Tolerance [print this page] A retiree necessarily has a different approach to investing than a young person. Each is in different financial circumstance. They've got different goals, prospects, and, most importantly, different timelines to achieve what they want. These differences support different risk tolerances for each - and therefore different investment choices for each.
We all invest for income and growth, and the more we can earn of each, the better. But unfortunately 'more' almost invariably comes with more risk. Higher returns inevitably are associated with higher risk. And higher risk means greater chance of loss. On the other hand, where there's very little or no risk, your effective return - after taxes and inflation - is often little, none - and perhaps slightly negative.
When you understand your tolerance for risk, you can choose the investments you make more consistent with that tolerance. That way, you'll sleep better knowing that tomorrow you probably won't be destitute. That's because although we like to seek big returns, no reward will ever be large enough if the consequences of losing are too much to bear. Realizing what we can't afford to lose is the first rule of responsible investing; and that's true for any age.
We can evaluate our risk tolerance by considering our honest answers to four questions related to your financial status, your goal, your acceptable loss level, and your need to risk. Here they are:
1. Financial Status - What is your present financial circumstance?
2. Goal - What do you want to accomplish through your investing?
3. Loss level- How much of what you have are you willing to lose seeking higher returns?
4. Risk Need - What's your risk need?
As a retiree, your financial status is determined by your income from social security and/or pension along with what your savings can supply you. How much of your living expenses cut into this income is important. That sets your lifestyle for your retirement.
You goal is, most likely as a retiree, to maintain your income throughout your retirement.
The amount of income and wealth you have determines how much you could lose of your investments yet still pretty much enjoy your same retirement lifestyle. If you've only minor savings all of which you count on, you'll not want to risk them at all. Realizing this Loss Level is very important.
Your Risk Need determines how much of what you have to risk really 'needs to be risked'. Again, if you're very wealthy, you have little or no 'need to risk' anything if you want to maintain your status quo. But the amount of wealth he can afford to risk - and lose -that won't interfere with his lifestyle - determines his Loss Level.
On the other hand someone who has savings sufficient only to just produce needed income, may need to risk some of it for growth to offset inflation. That way he maintains his status.
As an example, someone who has a high risk tolerance would be financially very comfortable, seek a solid increase in his investments, have a sizeable loss level, and be comfortable with risking what he can lose.
Whereas someone who has a low risk tolerance is barely secure financially, wants to maintain his status since he can't afford to lose anything, and doesn't want to risk anything.
by: Shane Flait
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