By Kyle Louvar, CFP®, AIF®
The word “risk” is frequently thrown around when it comes to financial planning and the stock market, but do you know what your financial advisor means when he or she asks about your risk tolerance? It’s easy to say that you are willing to take risks when things are good—when the markets are up, when you are making continuous progress toward your goals, etc. But what happens when the market cycle reverses and you find yourself losing money? Are you OK with risk then?
Many clients don’t realize how much risk is in their portfolio or the role that risk tolerance plays until it’s too late. At Guided Capital Wealth Management, we believe we have a responsibility to help our clients through conversations about risk so they fully understand how it can impact them in the long run.
Here we’ll discuss how to avoid the most common misconception about risk tolerance:
What Is Risk Tolerance?
Risk tolerance is a measure of your financial ability to withstand losses. Each person will have his or her own unique risk tolerance based on age, life circumstances, time horizon, and more.
Don’t Base Your Decisions on Time Alone
While the basic definition of risk tolerance often includes references to your time horizon (i.e., how soon you need to access your money), you shouldn’t make investment decisions based on that factor alone. This is the biggest misconception about risk tolerance I’ve seen among both clients and advisors.
Time horizon is an important factor, yes, but it certainly shouldn’t be the determining factor when it comes to overall risk tolerance. Conventional wisdom says that the longer you wait out the swings of the stock market, the more risk you can take on. But the truth is, aggressive investments do not always make sense—even with a long time horizon.
Get Specific About Your Reasonings
If you are going to take on risk, there should be specific reasons for doing so. Don’t take on risk because you think that’s what you’re “supposed” to do or because you think it is the only way to make any money.
While all investments involve some degree of risk, you do not need to expose yourself to huge swings in the market in order to make money. There are safer investments available that can provide growth and income too.
We often advise clients not to take on risk because there is usually little to no benefit. Think of it this way: Your portfolio faces both avoidable and unavoidable risks.
- Avoidable risks: Those that occur when your portfolio consists of unstable investments or when your holdings are not diversified appropriately.
- Unavoidable risks: Those that occur because our world is ever-changing, volatile, and we can’t predict everything. This type of risk includes unfortunate events like geopolitical issues, global pandemics, and economic recessions.
Given that the current market is teeming with unavoidable risks, it doesn’t make much sense to take on more risk than you have to.
How to Understand Your Risk Tolerance
To really understand your risk tolerance, you need to develop a clear picture of your financial goals.
You may be surprised by how much you can accomplish with a less risky portfolio. Yes, the higher-risk options will show you a greater earnings potential, but what is often forgotten is that the greater the earnings potential, the greater potential to lose your investment as well.
When thinking about your risk tolerance consider:
- Your financial objectives: What are you trying to achieve and by when? Risk should always be assessed in light of your objectives.
- Your overall financial picture: What are you willing to lose versus what are you able to lose?
- Your emotions: Even if some spreadsheet is telling you that your financial situation can handle risk, how do you personally feel about it?
Once you have a good idea of your own thoughts on risk, be sure you’re working with a financial advisor whose philosophy matches your own.
We Are Here to Help
At Guided Capital Wealth Management, we utilize our proprietary process, The Paradigm FORMula, to help you create a dynamic plan that can maximize your retirement potential and help keep you on track to achieving your goals throughout your lifetime—all while taking into consideration your personal risk tolerance.
Kyle Louvar is the CEO and Wealth Management Advisor for Guided Capital Wealth Management, a fiduciary financial advisory firm offering fee-based advice, guidance, and education. After seeing the impact that the 2008 financial crisis had on families, Kyle became fully committed to helping his clients develop a financial plan that changes as their lives unfold and their needs evolve. Spending nine years working for one of the largest brokerage firms on Wall Street, Kyle holds a high value for process, expertise, objective advice, and customized solutions. His goal is to help his clients experience confidence in their financial future through a disciplined process of financial planning, investment management, and sound financial decision-making.
Kyle graduated from New Mexico State University, where he was a proud 4-year letterman in football for the Aggies and where he’s sat as an NMSU Foundation board member since 2015. Kyle holds the CERTIFIED FINANCIAL PLANNER™ and Accredited Investment Fiduciary® certifications. When not helping his clients, Kyle enjoys spending time with his wife, Nicole, and their two daughters. You can often find him coaching his daughters’ softball teams, playing golf, cooking, and traveling. To learn more about Kyle, connect with him on LinkedIn.