Are you a risk-taker or do you play it safe? Do you jump out of airplanes for fun or is getting an extra serving of sprinkles on your soft serve your idea of risk? Each of us can look at our behaviors and determine whether the life we lead is high-flying risky or plain-vanilla safe. But can we do the same for our investments? Can you look at the stocks or funds you own and get a good idea of how risky your portfolio is? The answer is probably no.
There are some areas in life where we don’t mind leaping into the unknown —is that chocolate candy filled with caramel or coconut? However, being ignorant of the level of risk in your investment portfolio can have truly life-altering consequences. This is why it is so important to know how much risk you’re taking in your investments and how that risk should be distributed.
There are two sides to “risk” in an investment portfolio. Risk can determine how much the value of your investments could decline if the market moves in a negative direction. On the flip side, risk can also determine how much your investments could increase in value in a market that is moving higher. This relationship between risk and return is one we need to be very aware of when we are choosing an investment strategy. So how do we determine what the appropriate amount of risk is for our portfolio?
In a previous blog, we talked about using goals to determine “do I have enough?” We can use that same goals-based strategy to determine whether the risk we’re taking in a portfolio is “too much” or “too little.”
For example, let's say I want to buy a brand new TV, so I take the $1,000 I have saved up and invest in the S&P 500 for some extra growth. Am I taking the right amount of risk to accomplish the goal of buying a TV? If we experience something like we did in February and March of 2020 with Covid-19 bursting onto the scene, my $1,000 could quickly turn into $660. Now I’m not very happy because I’ll need to wait longer than expected to get that shiny new TV. But what if the goal is different? Let’s say instead of buying a TV with that $1,000 I want to set it aside for retirement. In that case, if my investment in the S&P 500 drops to $660 I may be upset, but the long-term timing of the goal and my ability to reach that goal is not materially impacted because retirement may not be for another 10, 20 or 30 years!
As you can see, there are times when a short-term drop in value could impact the goal outcome significantly. In those times we should try to reduce or even eliminate risk. There are other times when we are less concerned with the negative impact of risk and more concerned with the higher growth potential that comes with it.
In general, shorter-term goals can usually accept less risk, thereby reducing the potential loss, while longer-term goals can generally carry a higher degree of risk to achieve a better rate of return.
The amount of risk you should have in your portfolio should be correlated to your goals, but how do you take that knowledge and put it into action? This is where we would encourage you to talk to a trusted investment manager to provide guidance. The fact is one stock may be riskier than another. A basket of stocks may be less risky than one single stock. A stock fund may have more risk than a bond fund. A guaranteed product may have little to no risk, but often offers a much lower rate of return potential.
With all of the options available to investors these days it can be difficult, if not nearly impossible, to determine how much risk there truly is in your portfolio. An investment manager should be able to pick apart your portfolio and actually quantify the level of risk you are taking and propose a solution to match your investment risk to your specific goals.If you have not walked through this process with your investment portfolios, reach out to the Creekmur Wealth Team to start the process of analyzing the risk in your portfolio. You never know—if you are confident in the level of risk in your investment portfolio, you may feel more confident getting that extra serving of sprinkles.
Andy Anderson, CFP®