How Much Risk Can You Handle?

September 5, 2015

While investing in the markets is a great way to grow your savings, it is also risky and involves a great deal of uncertainty. One of the most difficult aspects of investing is dealing with volatility – the day-to-day ups and downs of the market. In the last decade, we’ve seen one of the worst drops in financial history. Consider the following 2008 drawdown statistics for the major asset classes:

 If your portfolio was invested in the S&P 500 in 2008, it would have dropped nearly in half and for many people it did; however, it has since completely recovered, gaining more than 200% since the bottom. There are two important lessons to be learned here. The first is that it pays to hold on. If you had panicked and sold out at the bottom, not only did you lock in a significant loss, but you also missed out on significant gains during the run-up.   The second, and arguably more important lesson, however, is to know your tolerance for risk. If you can’t hold on when your portfolio drops in half, don’t invest in a portfolio that has the potential to drop in half. When it comes to investing, we often come across clients who want huge returns but don’t want their portfolio to ever go down. The problem is, those two constraints are at odds with each other. If you want your portfolio to experience stock market returns, you have to accept the risk that goes along with investing in the stock market. At the same time, if you want the safety of investing in the bond market, you have to accept that your portfolio will likely return less than the stock market. The question you must then ask yourself is what is the appropriate balance between the two? Maybe it’s somewhere in the middle. If it is, then you should consider splitting your portfolio into half stocks and half bonds. If you’re conservative but would like to return a little bit more than the bond market, you might want to invest 75% of your portfolio in bonds and 25% in stocks.   What’s important is that you find a balance between the risks and returns that your emotions and your situation can tolerate. If you’re not sure what that balance is and would like to speak with someone about your personal risk tolerance, give us a call today.  We're always happy to help.

 

“Maximum Drawdown,” Zephyr, 2015, http://www.styleadvisor.com/resources/statfacts/maximum-drawdown

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