Risk Tolerance and Investing

If lying awake worried about an investment portfolio isn’t your idea of a good time, balancing your asset mix so it meets your risk tolerance is an important part of a successful financial plan. Even though sleep is a priority, achieving returns that meet the objective will ensure that long term goals are successfully met. Conservative investors who save into low return accounts and haven’t saved enough for retirement feel safe about their investment strategy until they don’t reach their goal. Planning a portfolio takes more work than filling out a simple risk questionnaire.

Begin With The Goal

A better strategy for investment success is to find out how much risk must be taken to reach the goal. By starting with the amount of money you have now and calculating the length of time and cost of the goal, investments that reach the objective will become evident.

This process helps prudent investors evaluate investments and decide if they can stomach the risk needed to take to reach the destination. If not, there are some important decisions to make. Should you retire later or retire on less money? If it turns out that you need to accept more risk in the portfolio, use these tools to help preserve your capital and sanity.

Stop Losses

Investors who fear their stocks will plummet the second they walk away from the computer love stop losses. These allow conservative investors to lower the chance they’ll experience huge losses in their positions. Stop losses are a trade placed below the current trading price that only executes if the stock drops to the predetermined point.

While stop losses are good, they don’t guarantee you’ll get the price at which you place the order. Once this price is met it triggers a market trade. In a fast-moving stock market this preventative measure still could execute a trade far below the stop loss point.

Some investors in mutual funds would love to have stop losses on their account. Unfortunately, stop losses don’t exist for mutual funds because they only trade once per day after the market has closed. This isn’t a problem for patient investors who expect long term results, not daily rises in their account value.

Quarterly Meetings

Reviewing a portfolio’s performance quarterly is recommended by many financial experts. Compare mutual fund manager’s returns the past quarter to the competition. If the market is down, the portfolio may also be down, but shouldn’t have returns significantly below common benchmarks. Finally, compare the portfolio’s results to the end goal to see if objectives are being met.

Although quarterly reviews of your portfolio won’t automatically fix financial account problems, staying on top of financial accounts can help ease worries about a portfolio’s direction. It’s easy to think of the financial markets as magical when you don’t follow them on a daily basis. However, as you learn how investments work, it’s not hard to begin to understand downside risks and monitor those areas closely that are threats to the portfolio.

Annuity Provisions

Some investors hoping to be more aggressive with their investment strategy but worried about market downturns look to annuities. These can be attractive investments for investors with a low risk tolerance because of the insurance provisions offered inside of these tools.

Equity indexed annuities allow investors to lock in a portion of the gains enjoyed by the financial markets. The contract helps nervous investors unsure about the market because indexed annuities eliminate the risk of loss when financial markets tumble.

Variable annuities offer investments in stocks and bonds that often gyrate with the roller coaster activity of the stock market. However, investors with a low risk tolerance can purchase riders such as a guaranteed minimum withdrawal benefit. This rider allows variable annuity owners to withdraw funds from their account during retirement while guaranteeing that the contract holder won’t outlive their funds.

Cash Reserves

Investors nervous about investments are often afraid that funds won’t be available when a financial need arises. If this investor prudently places enough money in cash reserves to ride out a downturn in the financial markets, they can feel safer about taking risks with longer term portions of the portfolio.

Cash reserves are liquid but offer paltry returns. Successful investors find creative ways to boost returns while keeping cash reserve funds out of the financial markets. One method often used is to ladder CDs. An investor buys a one year CD once a quarter for a year. At the end of the year, if the investor had no need for cash, she has money coming due every three months and a significantly higher interest rate than a savings account.

Investors worried that their ability to sleep will be impacted by their portfolio should look into one or more of these options to control risk. Frequent portfolio reviews help investors stay on top of trends so they feel more comfortable with the many risks inherent in even conservative investment strategies. Large cash reserves shield riskier investments from being touched during protracted market downturns. Annuity provisions and stop losses are automatic levers that an investor can use to minimize downside risk to a portfolio. A few of these used by a conservative investor can have them sleeping soundly in no time.

Because everyone has different goals, there is no golden risk reduction strategy that works for every investor. By starting with your goals and deciding which risks you’re comfortable taking and which need to be minimized, you’ll create the perfect plan.