| Suzanne Himes, CFP®
Why do we talk so much about risk assessment? The financial markets are always reacting to a variety of global events and this volatility can be unnerving for individual investors, especially if investing without first understanding one’s personal risk profile. So, how do you begin to decide how much risk to take with your investment accounts?
First, it’s important to remember that market volatility is a risk that investors implicitly agree to take on, with the expectation that they will be rewarded for taking that risk. But in more personal terms, risk is really the chance that things won’t work out; that our individual financial goals won’t be met.
Next, let’s think about the types of risk to consider. A strong financial risk assessment, or risk profile, looks at three different aspects of risk:
- How comfortable in general are you with taking a chance. Are you naturally wired more conservatively or more aggressively? This is sometimes referred to as your “risk DNA”.
- How much risk can you absorb without needing to change financial goals? The ability to weather an economic storm. In other words, will your most important financial needs still be met if you lose a portion of your assets?
- How much risk is necessary to achieve your future financial goals? You may need to take on more risk in order to make up for a shortfall of savings, or modify your goals so that more conservative investments will still support your goals. On the other hand, you may be able to reach your goals with less investment risk than you thought.
With this in mind, there are several important factors that can influence our risk profiles:
- Personal investment experiences – Your own life experiences related to money.
- Time horizon – The longer it is, short-term volatility will generally be easier to withstand.
- Inflation risk – The longer the time horizon, the more exposed you are to inflation and so you may need more investment growth to maintain your purchasing power.
- Relationships – It is important for couples to discuss their investment strategy periodically. Make sure you are on the same page.
So, back to the original question. Why do we talk regularly with clients about risk assessment? Approaching an investment strategy in a thoughtful way can boost the likelihood of sticking with your plan through the inevitable short-term stresses, and contribute to your long-term financial planning success.