Are You Playing It Too Safe? Fee-Only Financial Planner Looks at Risk Later in Life
When it comes to financial planning, taking on too much risk can wreck your nest egg if you’re not careful, but being too risk-averse can likewise rob you of your future gains. So, what’s the best path forward?
The fee-only financial planners at Linscomb & Williams take a closer look at risk, both in your younger years and as you transition into retirement, and how you can make the most of your investments.
What is Risk Tolerance?
Simply put, risk tolerance is how much risk you can tolerate before abandoning your investment strategy or selling an investment prematurely. Risk tolerance can vary from person to person and can be as unique as your fingerprint.
There’s no right or wrong answer for risk tolerance. What’s more, your risk tolerance may change over time due to a number of factors.
Life Events and Risk Tolerance
One of the biggest determinants that can change your risk tolerance is a life event. This can be any incident or occurrence that changes your goals, outlook or even family make-up. Life events can be positive or negative. Getting married, having a child, going through a divorce, or receiving an inheritance are all life-changing events. All of these may change how you look at your investments, and, in turn, your risk tolerance or capacity.
Another factor at play is the time horizon associated with your financial goals. For example, if you start early enough, investing for your retirement can be a decades-long strategy, giving you more time to make up any loss you may experience. However, if you get a late start to your retirement planning, you will have a much shorter time horizon, and a short-time horizon doesn’t give you that cushion.
The longer your time horizon, the more aggressive you can potentially be.
Risk capacity is different than risk tolerance. While risk tolerance is more subjective, risk capacity is objective and can be measured. Risk capacity is defined as how much risk is essentially “required” to obtain the gains you need.
Here’s an example:
Suppose you are 53 years old, aiming to retire at age 65. You have big travel plans for retirement, which can be expensive. After reviewing your plans, your financial advisor may determine you need to generate a 9 percent annual return, on average, to support these goals when retiring in 12 years.
Generating this level of return requires a moderately aggressive portfolio. However, your risk capacity may be more aggressive than what your risk tolerance suggests you’d be comfortable with.
What’s your risk capacity? Use our new guide to determine your retirement personality and how it affects your finances.
Your Goals: Pursuing Growth or Preserving Wealth?
As a fee-only financial planner in Birmingham, AL, it’s also important to dig into the “why” behind your portfolio strategy and investments, as it has serious implications for your risk tolerance.
An investor looking to grow their account value will almost certainly need to take on a certain level of risk to achieve it. Historically, the stock market has achieved some of the highest gains in the investing world. But stocks generally carry more risk in the short-term than investments like bonds.
If you are looking to preserve your wealth and reduce the risk of losses, then you’ll lean toward more conservative investments. Though a conservative portfolio may limit your growth potential, it can offer more in terms of wealth preservation characteristics.
Why a More Conservative Approach May Not Make Sense
Most people associate “conservate” with “safe.” But as fee-only financial planners in Birmingham, AL, we’ve learned that’s not always the case. A conservative portfolio may be a risky proposition for your retirement if you need growth to reach your financial goals.
If you have more than 10 years until you’ll be using the money you’re investing, using a conservative portfolio strategy can leave valuable return opportunity on the table. With items like inflation and ever-increasing taxes, over-insulating your portfolio can rob you of even moderate gains, which can go a long way considering potential compounding.
The key is balance. Work with a financial planner to find your balance between safety and portfolio growth.
How a Financial Advisor Can Help
Do a quick Internet search, and you’ll find at least a dozen online risk tolerance tests. However, there are many things these quick, five- or six-question tests won’t tell you.
For example, while you may find that you’re an “aggressive” risk-taker, have you considered other investments you currently hold, such as real estate, company stock or a business venture?
Also, if an online test labels you a “conservative” risk-taker, will a conservative approach allow you to reach your goals?
As fee-only financial planners in Birmingham, AL, we have observed in our 50-year history that most people’s risk tolerance falls somewhere in between aggressive and conservative, but maybe a bit higher or lower than your standard “moderate” category. At Linscomb & Williams, we help clients articulate their goals and needs, and only then, determine their true risk tolerance. Blending your assets and goals together, a financial planner can help you understand the risk capacity required to reach your goals, and help you understand if your risk tolerance is appropriate. If your risk tolerance does not align with your risk capacity, a financial planner can help you adjust your financial plan accordingly. Doing this on your own can be extremely complicated and may feel overwhelming.
Linscomb & Williams is a fee-only, fiduciary financial planning and investment management firm headquartered in Houston, TX, will offices in Georgia and Alabama that serve investors nationwide. We have 50 years of experience helping families build, preserve and manage wealth. If you’re wondering if you’re playing it too safe with your investment strategies, let’s talk. A simple conversation can make a big impact.