Risk: How much can you stand? How much do you need?
Joel Dresang: Isabelle, when you advise investors, you spend a lot of time talking about risk. How do you assess the risk tolerance of investors?
Isabelle Wiemero: Well, there are a number of surveys and quizzes out there that investors can take that will put them into a certain risk category. But for us as advisors, it’s really important that we get to know our clients to really know how much risk they can take.
And in doing that, we need to know three main things:
- What’s their time horizon?
- What are their goals and expectations?
- And how much volatility can they emotionally handle as an investor?
Joel: So, the time horizon seems pretty straightforward. If you’re younger, then you’ve got more time to recover from any risks that you take.
Isabelle: That’s right and it’s really a moving target. When you’re younger, you have a lot more years ahead of you of investing, and you can likely take on more risk and feel comfortable with that.
As you get older and older, and closer to the age where you’ll be withdrawing money, the amount of risk you’re willing to take typically goes down. This is why it’s so important that we know when a client is planning on taking money out of their portfolio.
Joel: What about goals and expectations? How does that figure into how you know somebody’s risk tolerance?
Isabelle: Well, we need to know what the money is going to be intended for because the answer to that question can be very telling on how much risk someone’s willing to take.
Is this money that you’re going to depend on for income in retirement, or is this something that you think is going to be left over to your heirs?
It can also be really telling just to have a conversation with a client and see what their expectations are for their account. Are they someone who watches an index closely and wants to keep pace with that? Or are they less concerned with that and just want to experience some market gains but more concerned about preserving their capital when markets hit tough times.
Joel: So, what about the disconnect that sometimes can occur when somebody thinks that they have a certain risk tolerance but what their expectations are for their money requires more of a risk?
Isabelle: Right, and this can happen quite often. And if you get into a situation like this, the client’s typically going to have to make a choice. They may need to take more risk than they’re willing to in order to meet their financial goals. They’re either going to need to be willing to assume that risk or invest to the risk that they’re comfortable with. But that’s going to mean you’re going to have to make changes elsewhere, perhaps changing the way you’re going to spend, years down the road.
Joel: So, I can see that’s where the emotions come into play because you have to take risks to make money over time.
Isabelle: That’s right. Nobody likes to lose money, and so much of this has to do with how much volatility you’re willing to handle as an investor. Can you handle seeing a down statement for a quarter? Are you somebody who gets nervous and wants to make changes right away, or are you able to sit tight and wait for the market to come back? What happens if it’s more than a quarter? What if it’s a couple quarters or even a few years?
Joel: So what do you do? How do you adjust their allocations to help them?
Isabelle: Once we know a client’s risk tolerance, we can build an allocation around that. A way that we do that is use bonds in a client’s account to help offset the risk that they’re going to be taking.
Bonds are the vehicle that we can use to help give clients confidence to take on more risk with the other part of their account
Joel: So, I can see where that would be particularly helpful in retirement.
Isabelle: That’s right. When someone gets closer and closer to retirement, we’ll start putting even more and more towards the bond portion of the account, the historically less volatile portion. And again, it’s all about the time horizon and the moving target. As you get closer and closer to needing to draw the funds, we’ll put more into the safer portion of the account.
Then you don’t have to be as worried about the risky portion, knowing that you’re not going to need to draw from it for a number of years. And that’s what can give you the confidence as an investor to stay in the market even when times get tough.
Weighing all the risks, by Chris Evers
Beta: Learning how risky an investment might be, a Money Talk Video with Kyle Tetting
Talking Money: Measuring risk/reward, a Money Talk Video with Kyle Tetting
Efficiently lining up reward and risk, a Money Talk Video with Steve Giles
Isabelle Wiemero is an investment advisor at Landaas & Company.
Joel Dresang is vice president-communications at Landaas & Company.
Money Talk Video by Peter May and Jason Scuglik
(initially posted Nov. 23, 2015)
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