Are you taking too much risk to achieve your financial goals, or not enough?Submitted by FSB Premier Wealth Management on October 31st, 2014
One of the biggest dangers in investing is picking an investment strategy that makes it difficult for you to sleep at night. If the risk is more than you can tolerate in a down market, then you’ll panic and sell when you shouldn’t. This was very evident during the recent pull back in the market a few weeks back as we saw some people dump everything over their fear the markets would plunge further. Today, the market is back near all-time highs. On the other side of things, most people don’t want to take more risk than they “must” to achieve their financial goals. We look at two measures of risk when helping clients with their financial goals, risk tolerance and risk capacity.
Risk Tolerance vs. Risk Capacity
Investopedia defines risk tolerance as “the amount of risk that an investor is comfortable taking, or the degree of uncertainty that an investor is able to handle.” Risk tolerance varies with age, income and financial goals. There are many ways to determine risk tolerance, but most financial advisors will use a risk questionnaire of some sort to help determine the level of risk that you would be comfortable taking.
Risk capacity, on the other hand, is defined by Investopedia as “the amount of risk that the investor “must” take in order to reach financial goals.” To know what your risk capacity is, you need to have clearly defined goals. For example, let’s say you want to save $100,000 over the next 20 years for your child’s college education. Now that you have identified a specific, measurable goal, you are able to zero in on the types of investments available that may generate the type of return needed to achieve it.
For many investors, their level or risk tolerance is not the same as their risk capacity. When the amount of necessary risk to achieve a goal exceeds the level you are comfortable taking, you will most likely not achieve the goal. On the other hand, when your risk tolerance is higher than the risk level needed to achieve the goal, you may be taking undue risk.
It’s so easy for us to let investing become emotional, but we need to maintain a disciplined approach based on our own personal risk tolerance and risk capacity. Working with a financial professional may prove beneficial when it comes to defining your risk situation. They can look at your situation from an objective view and are not hindered by your emotions. Contact me today to review your financial goals and risk situation!
Jordan Alborn, CFP® - VP/Financial Advisor
FSB Premier Wealth Management, Inc.
This material is provided for general information and educational purposes based upon publicly available information from sources believed to be reliable. Any opinions expressed are my own, which are derived from my experience and background as a financial advisor. They do not represent those of my employer, FSB Premier Wealth Management, Inc., or any of its affiliates including Farmers State Bank.