An age old question in investment suitability is “how much risk do I take?” and it’s a key consideration in your investment activities. Naturally changes in life circumstances may change your tolerance for risk over time, but self-reflection helps in this area so you can be confident that you’re making smart financial decisions which are aligned with your current risk tolerance.
Factors impacting your risk tolerance at any given time include demography, stability of income, your goals, and your current lifecycle stage. Your risk tolerance will serve as a guide for weighing appropriate risk vs return in your investment decisions, so let’s get an understanding of each factor so you can make a good self-assessment.
Factor 1: Demography
First, in determining risk tolerance demographics come into play. Based on age, gender, marital status, income, occupation, family background, and current wealth, each individual will have different feelings towards risk. For example, younger clients are typically willing to take on more risk, as are those with higher incomes and larger net worth.
Factor 2: Stability of Income
Next, stability of income is also an important factor in determining appropriate risk tolerance. Individuals with stable income and good job prospects in the case of job loss have less to worry about than those who have a track record of less stable employment and income. Those with stable income can afford losses, while those with less stable income often cling to any savings they have and are less willing to take risks because they perceive money to be harder to replace.
Factor 3: Your Goals
Another key consideration is what your goals are. If there is a large gap between where you are today and where you need to be, you’ll have to be willing to take more risk than someone who is already at or close to their stated goal. The shorter the timeframe to achieve your goal the more risk is required.
Factor 4: Lifecycle Stage
Lastly there is a life cycle theory which breaks down 4 stages of life, and explains how people are generally willing to take different risks at different stages. Here are the characteristics of the 4 stages:
1. Accumulation – At the start of someone’s career they typically have few assets, and higher liabilities such as student loans or a mortgage on a first home. Usually savings are small and any equity they have in a home is the largest asset. Since income is lower at the initial stages of a person’s career they typically have lower disposable income since most income goes towards covering daily living expenses. However, a longer time horizon means a greater ability to take on risk.
2. Consolidation – The second stage is where income from the career is more than enough to comfortably exceed expenses and there is more disposable income which can be put towards savings and building the portfolio. In this stage a significant portfolio has been built and income is good so the ability to take on risk continues.
3. Financial Independence – Later individuals reach their goal of financing independence where they no longer need to be part of the workforce to cover their expenses. Once they have left the workforce they rely on investment income from their high net worth rather than their career income to cover expenses. At the ability to replace losses from career income disappears so risk tolerance is reduced.
4. Gifting – The final stage may occur later yet where an individual realizes that their assets exceed their needs and they may decide to share wealth with the family or charitable organizations. For example, they may wish to help children with education, their first home, or helping to fund the retirement of their children.
Self-assessment starts with self awareness. Are you conscious of your own biases and how your age, gender, upbringing, current career, and existing net worth form the lens through which you view investing decisions?
Next, how to you perceive your income security? Realistically what are the odds of a loss of income for more than 6 months at this stage in your career? Given the answer how much of your savings are you willing to take smart risks with in order to receive maximum returns, and how much do you need to keep aside for a rainy day fund?
After assessing where you are currently at, the next question is what are your goals? What is your target retirement age? What is your target retirement lifestyle? How much net worth will you need to make that a reality? These are all things your wealth advisor can help with but asking the right questions will help you understand where you are today, where you are going, and what needs to be done to bridge the gap to make your retirement dreams a reality.
Next what lifecycle stage are you currently at? How soon will you be moving to the next one? And, is your current risk level suited to your current stage?
Professional Help vs. DIY (Do It Yourself)
Financial planning isn’t a do-it-yourself sport. With mediocre advice, you’re most likely to end up with mediocre results. Leaving your financial future to chance is a poor idea (pun intended) so make sure to get a professional on your team.
No mortgage or financial planning team in this country does more borrowing to invest or borrowing for wealth creation than our team. We have the business track record and formal education to support your plan and to help you achieve your financial goals. Volatile markets create opportunities and we would love the opportunity to help you capitalize. Call our office today to discuss how we can help at 1-855-410-9905 or email ClientCare@MortgageManagement.ca