UNDERSTANDING RISK TOLERANCE
“The biggest risk is not taking any risk… In a world that changing really quickly, the only strategy that is guaranteed to fail is not taking risks.” – Mark Zuckerberg
When I ask potential investors what their investment objective is, they invariably answer, “To make money with no risk. Isn’t that everyone’s goal?” As long as markets move higher, investors seem willing to take on more risk. But with growing worry over stock market valuations, impending interest-rate hikes and the Greece “No” vote and its impact on both the European Union and on the Euro, now may be a good time for investors to take a step back and think about their current portfolio risk level.
Although all investments possess an element of risk, including the potential loss of principal, securities such as stocks, even dividend payers, are more risky than other types of investments. At the same time, although higher risk investments may have the potential for higher returns, they can also lead to greater losses. Therefore, the higher an investor’s risk tolerance is, the more he will invest in higher risk securities offering the potential for greater returns.
Terms
Investment objectives span a wide spectrum. Investors seeking to generate income to live off of have much less exposure to risk in their portfolio, while those who are involved in trading and speculation generally take the most risks. Similarly, risk tolerances follow a spectrum starting with “Conservative,” then “Moderate,” and finally “Trading/Speculating.” Each stage involves a higher level of risk. The definition of Trading/Speculation is suitable for investors seeking out maximum return through a broad range of investment strategies generally involving a high level of risk, including a potential, significant loss of principal. On the other hand, a conservative income investor would be defined as an investor seeking the maximum amount of income consistent with a modest degree of risk.
For example, a client with a long-term risk tolerance can deal with short-term market volatility that comes with a portfolio of higher risk investments. This is because the investor has a long-term time horizon, and he seeks the higher long-term return potential associated with these higher risk investments. Conversely, a retiree who is living from the income generated from his portfolio can’t afford to take those same risks because he needs to know that he will be able to generate enough money to cover his expenses, and not lose any principal.
Keep it Current
A common problem, among investors, that I see regularly is that their portfolio hasn’t been updated in years. An appropriate investment at the age of 35 may have outlived its usefulness by the time the investor reaches the age of 60. This situation is especially the case for people who have immigrated to Israel, leaving investment accounts behind in the United States. While their portfolio was suitable to their situation back in Boston 12 years ago, it may be completely inappropriate as a retiree in Haifa.
Take Stock
It is vitally important for individual investors to take stock of their current investments, as well as their specific investment objectives. To begin, define your actual financial goals. Include short-term objectives, such as paying for a child’s kaitana [day camp], as well as more long-term objectives, such as marrying off your children and paying for your own retirement. Once these goals have been defined, the investor should look at his portfolio and see if he is either being too aggressive or maybe even too conservative to achieve these objectives. If you feel that you are not capable of such analysis, it may be worthwhile seeking the help of a professional adviser. A licensed professional adviser will help you take an objective look at your current holdings and give recommendations for making your portfolio more efficient and compatible with your particular situation. Use your adviser as a sounding board. He can tell you if your goals are realistic, and if not, you can work together to come up with goals that can be achieved.
The information contained in this article reflects the opinion of the author and not necessarily the opinion of Portfolio Resources Group, Inc. or its affiliates.
Aaron Katsman is author of the book Retirement GPS: How to Navigate Your Way to A Secure Financial Future with Global Investing (McGraw-Hill), and is a licensed financial professional both in the United States and Israel, and helps people who open investment accounts in the United States. Securities are offered through Portfolio Resources Group, Inc. (www.prginc.net). Member FINRA, SIPC, MSRB, FSI. For more information, call (02) 624-0995 visit www.aaronkatsman.com or email aaron@lighthousecapital.co.il.
