Many financial advisers and pundits tell investors to take on as much investment risk as they can take. Is that always the best idea for you?
Mary sits down with a financial adviser to review her retirement accounts. This adviser has Mary fill out a “risk tolerance” questionnaire. This form tries to determine how much risk she can stomach. He then tells her that she should invest at that highest risk level to grow her savings faster. Should she?
Expecting a risky investment to provide a handsome return if it pays off is common sense. The adviser explains that if Mary invests in riskier investments, then she should expect to have more money in retirement. Why would that approach backfire?
- She may realize she cannot accept that much risk. Remaining calm during market turmoil can be difficult. The media screams about the direction of the stock market. Even the experienced opinion of a financial adviser cannot always overcome fears and emotions. Making matters worse, becoming more conservative DURING market downturns may lock in the loss Mary already took!
- She is too close to retirement. Smart investing at age 40 uses different rules than at age 60. An investor nearing retirement may feel comfortable taking on a lot of risk. If their portfolio loses money in the next few years, though, it may not have time to recover. A smart balance of risk and return is crucial in the years leading up to retirement!
- She can afford to take less risk. Should Mary remain in a risky portfolio if she can only expect a 5% higher income in retirement? What if that same portfolio puts 20% of that income at a higher risk? Mary may sleep better at night in exchange for slight cutback in expectations.
A More Informed Choice
In Mary’s case, she changed advisers to one who helped her understand the trade-offs. She no longer had to have her fears and concerns ignored with platitudes like “just ride it out”. Instead, she worked with her adviser to understand the impact to her goals if she reduced her risk. In the end, she accepted that trade-off and no longer worried about her investments.