There are many factors to consider when determining your risk tolerance.
How do you incorporate your age into determining your investment allocation?
Do you subscribe to the 100 minus your age theory for how to determine the stock-to-bond mix? Or perhaps you are using a target date fund that automatically gets more conservative as you get closer to retirement?
Whether you have a strategy or not, many investors believe that as they get older, their portfolios should get more defensive. “Given my age…” is a phrase I hear a lot as I work with clients and prospects. Surprise! Age alone should not determine the way you invest.
The truth is…while your age may be a significant factor in the portfolio allocations we recommend, it usually is just one of many factors we consider when recommending Personal Portfolio allocations to our clients. Depending on your specific financial circumstances, sometimes age plays a minimal role, or is not a factor at all.
If you are being invested more conservatively based solely on age, you could be leaving money on the table – and who wants that?
Broadly speaking, there are two additional factors to consider as you build the right investment plan for yourself and your family. These may be just as important – and often more important – to consider than your age.
Capacity for risk.
Your risk capacity for any given account speaks mainly to your short term and long term financial needs. You may have different risk capacities for different accounts.
If you need to start pulling money out of an account next year, it may have a lower capacity for risk compared to an account you don’t plan to touch for another 10 years. The longer the time horizon for a particular account, the more aggressive you can be.
The sooner you need money, and the more dependent you are on the portfolio, the lower your capacity for risk in that account. You would need to protect funds designated for the short term, because you know you’ll be accessing them soon.
Conversely, the longer you can wait to access your funds, and the less dependent you are on the portfolio, the more aggressive you can be.
Perhaps you are 65 or 70, but you are still working or perhaps even running your own business. Maybe you are passionate about your work and have no plans to retire any time soon. In this case, age may indeed be “just a number” as you may not need to access the funds in your portfolio for some time.
Tolerance for risk.
Your risk tolerance speaks to your emotional reaction to portfolio fluctuation.
If you would likely sell after a 10% market drop, you have a lower risk tolerance than if you would have held. On the other hand, if you would consider buying after a 10% market drop, you have a higher risk tolerance.
Your overall tolerance for risk is an important factor to understand for a healthy, wealth-building financial strategy.
The good news is that your tolerance for risk can vary by account. You can be conservative with some accounts and aggressive with others. However, investing more aggressively than your comfort level could lead to shifting strategies at the wrong time, thereby potentially compounding locked-in-losses. On the other hand, investing more conservatively based solely on age could mean you are missing out on potential growth.
Your portfolio should strategically evolve as you get older. While it may happen that your capacity and tolerance change as you age, it is not your age alone that impacts those decisions.
Here are just a few reasons for keeping your foot on the gas into your 60s, 70s, 80s and beyond:
- You are investing for the next generation.
- Your income sources cover your living expenses.
- You over-saved (congratulations!) and your distributions make up a very small percentage of your portfolio.
If your portfolio is being managed based solely on your age, and not factoring in risk capacity and risk tolerance, you could be giving up the potential for more growth in your account.
Wealth can be created, or destroyed, based on how well your true capacity and tolerance is aligned with your account allocation. Reflecting on your emotions and any financial changes you may have made over the last few months is a good starting point for reevaluating. Even for the most risk tolerant, some angst is normal.
Risk is not a zero-sum game. It’s strategic.