Three Ways Risk Tolerance Can Shortchange Your Portfolio

The goal of investing is simple: to grow your assets. Yet investing involves risk, which means you may end up with less than you started with. Without risk, however, there’s no potential for reward. That’s the investor’s quandary—how much risk is tolerable in the quest to meet your financial goals? As you review your investing strategy for the upcoming year, consider how your risk tolerance may be affecting your portfolio.

Personalities and life experiences shape risk tolerance

Your comfort level with risk has roots in your personality and life circumstances. For example, growing up in a financially strained household or living through a period of economic difficulty can dampen your enthusiasm for investment risk. Whether you are generally optimistic or pessimistic can also influence how much risk you are willing to take. On the other hand, there are the thrill seekers who are drawn to the potential for large gains. Generational influences can also shape whether you lean toward financial restraint or have a more carefree attitude about money. For example, men tend to be more likely to embrace risk, while women may be more cautious.

A 2015 Ameriprise study, Financial Risks & Investor Attitudes, found that many U.S. investors allow their feelings about risk to influence their investment behavior in ways that are detrimental to their financial goals. Three risk profiles illustrate how attitudes can trip up the best investment intentions.

1. Avoiding risk at all costs

For example: A retiree receives a monthly income from Social Security and a generous pension. His combined income has been sufficient to meet expenses and his lifestyle, so he hasn’t had to dip into his savings. Despite his financial comfort, he is only comfortable investing in assets that provide a fixed return or allow him to cash out quickly.

In this example, the retiree represents a risk-adverse investor. He has the financial leeway to invest in higher yield investments, which offer greater growth potential, yet he chooses a more conservative path. Does this sound like you? If so, your dislike of risk may be hampering your ability to capitalize from a more diversified portfolio. At the minimum, make sure your investments are keeping up with inflation. Talk to your financial advisor for reassurance if you suspect you can handle more investment risk.

2. Overreacting to market changes

For example: A working couple with two teenagers contributes the maximum amount to their employer-sponsored retirement plans, with the intention of retiring in 15 to 20 years. They’ve taken care to purchase sufficient insurance to protect their family. After the last market downturn, they redistributed their portfolios to hold only low-risk investments.

Are you like this couple, quick to react to external events without considering the long-term? A balanced portfolio can help you weather bumps in the market that tend to even out over time. Your financial advisor can help you employ a consistent strategy that periodically rebalances your assets to align to your investment goals and time horizon.

3. Investing beyond your capacity to withstand losses

For example: A middle-aged single architect earns a good living but has difficulty setting aside funds for the future. She enjoys researching and investing in startup ventures in the technology sector. She admits to investing in long shots, hoping to hit the jackpot.

Investing in high-risk investments when you have limited assets or a short time horizon is asking for trouble. If you are tempted to take bigger risks than your portfolio can withstand, enlist a financial professional to help you maintain a more disciplined approach to investing.

Find Balance and Opportunity in Risk

If you relate to any of the three scenarios above, your risk tolerance may be preventing you from reaching your investment goals. An experienced financial advisor can help you arrive at investment decisions based on financial principles rather than emotions. Together you can factor in your assets, time horizon and capacity to manage losses as you select investments with the best chance of generating optimal returns.

Rob Davis lives in University Place with his wife Lorri and their youngest son, Parker. He is a Financial Advisor and CERTIFIED FINANCIAL PLANNER practitioner™ with Ameriprise Financial Services, Inc. in Tacoma, Washington. Rob specializes in fee-based financial planning and asset management strategies and has been in practice for 38 years. He is licensed/registered to do business with U.S. residents only in the states of Washington, Idaho, Arizona and California. You may contact Rob at ameripriseadvisors.com/robert.g.davis.

Diversification can help protect against certain investment risks, but does not assure a profit or protect against loss.

Ameriprise Financial and its affiliates do not offer tax or legal advice. Consumers should consult with their tax advisor or attorney regarding their specific situation.

Investment advisory products and services are made available through Ameriprise Financial Services, Inc., a registered investment adviser.

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