- July 10, 2017
- Posted by: Parker Evans, CFA, CFP, CMT
- Categories: Bonds, ETF, Financial Planning, Financial Planning and Investment Blog, Portfolio Management, Retirement Planning, Retirement Strategies, Stocks
Investors should periodically evaluate their risk tolerance with the help of a skilled financial advisor. The award-winning FinaMetrica Risk Tolerance Profile provides an invaluable tool for assessing investor risk tolerance.
One of the most unpleasant surprises in life is to discover you have suffered a significant loss because you under-estimated risk. Over-confidence can lead to impulsive, wealth destroying investment behavior. Pride goeth before a fall. Remember most market movement is random. As Yogi Berra said, “prediction is difficult especially about the future.”
What’s also disappointing is to find you have not made the most of your opportunities because you over-estimated risk. Excess pessimism leads to poor investor outcomes. Opportunity cost is real. Remember it helps to think longer-term. Economic recession and falling markets eventually end. Growth resumes.
In this context, it’s important to educate yourself about capital market risk and return. Also, you must understand your willingness and ability to accept investment risk. Willingness is related to your attitude and personality. Ability is a function of your financial strength and earning power. The two don’t always match.
The Risk/Return of a Well-constructed Portfolio Stems from its Defensive/Growth Split
Bonds are defensive assets. Stocks are growth-oriented assets. Your FinaMetrica risk tolerance score indicates what percentage of growth assets that you should be comfortable holding in your investment portfolio.
For example, from the table shown above, a risk tolerance score of 50 translates to 50% growth assets, meaning that a client with a risk tolerance score of 50 will be comfortable with an asset allocation that has 50% growth assets (stocks) and 50% defensive assets (bonds). In a well-diversified portfolio, volatility and risk are not highly sensitive to the percentage of growth assets. A client who is comfortable with a portfolio holding 50% growth assets will also be OK with the risk of investing between 45% and 57% in stocks.
For more information see FinaMetrica’s Guide to Investment Risk and Return.