What’s Your Risk Tolerance
Updated: Feb 17
Risk is a factor in any investment decision that you make and your tolerance for risk is something that you will want to consider within your investment strategy. Your risk tolerance is balanced against your time horizon, meaning the time between now and when you anticipate needing your money.
Is it possible to avoid a loss? No, not completely, but you can take steps to manage that risk when investing. This is where conversations with your trusted financial advisor about risk tolerance are critical.
What would you rather have, $500 right now or a 50% chance at $2,000? Many people go for the $2,000 and rightfully so. Since you have a 50/50 chance, a decision tree shows the $2,000 answer carries a potential value of $1,000.
But let’s add a few zeros and see if that changes your perspective.
What would you rather have, $50,000 right now or a 50% chance at $200,000? The decision tree says the opportunity to win $200,000 has the highest potential value. But in reality, many people second-guess that decision because $50,000 is a lot of money.
Remember, there is no correct answer to these questions. They simply help you better understand the concept of risk.
Timing and Concentration
Investment risk is related to the timing of decisions you make. The value of your stock portfolio moves up and down, sometimes dramatically. If you sell when prices are up you will do well. If you sell when down, you take a loss. If you understand the likely changes in your portfolio before you invest, you will be more inclined to invest for the long term which is the best way to meet your goals. A good financial advisor will educate you on the range of outcomes before investing your hard earned money.
Another risk is concentration risk. If you invest in a single stock or crypto-currency, the probability of your investment becoming worthless is greater than if you invest in a diversified portfolio with hundreds of stocks. With hundreds of stocks, if one company fails, others will survive and may even flourish if they are better managed or in a different industry.
Investment risk can be managed, but it can’t be eliminated entirely. All investments carry some level of risk. And in general, the greater the risk an investment carries, the higher its potential return. Many people build wealth through concentrated investments, but maintain wealth through diversification.
Find out if your portfolio is within your comfort zone. Begin with our 5 minute risk questionnaire.
Risk should be considered when you invest, but don’t let it get in the way of your dreams.
Ultimately, your risk concerns should inform discussions with a financial advisor. This conversation should include the time horizon, the goals you hope to realize from your investments, and the risks each investment strategy presents to meeting your goals.
Are you comfortable with your progress towards retirement? How about helping future generations meet their financial goals? If you have more than $2 million saved and need help from a wealth manager, the Peak Wealth Planning team can assist.
Peak Wealth Planning specializes in helping high-net worth individuals and families plan for the future.
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About the Author
Peter Newman is a Chartered Financial Advisor (CFA) and president of Peak Wealth Planning. He works with individuals nationwide that have accumulated wealth through company stock, ESOP shares, real estate, or running a business. Peter applies his unique background to help clients achieve their specific goals and enjoy peace of mind.
Peak Wealth Planning provides concierge services to meet your wealth management needs. Services include: financial planning, investment management, esop diversification, retirement income, insurance, and estate planning advice. Peak Wealth Planning is a fee-based financial advisor based in Champaign, Illinois, and Fraser, Colorado.