Kyle Swaim
TB Group LLC
Elon Musk reportedly told his bankers that they would not lose any of the money they put up to help him buy Twitter. But a recent calculation puts the value of the company at $25 billion less than Musk paid for it. If you can’t put your faith in the investing advice of the richest man in the world, who can you trust? The truth is, you’re better off putting your trust in your own risk tolerance.
Risk Tolerance Is Situational
Basically, your risk tolerance is a measure of how willing you are to take a loss in your investments. It’s obviously not constant. You might have a higher risk tolerance for a $100 investment and a much lower one for a $100,000 investment. Personally, I think risk tolerance is situational, that is, it varies with the situation. It’s not like your IQ, which supposedly doesn’t vary much with context.
To get a feeling for the concept of risk tolerance, and perhaps learn a little bit about yourself, check out the Investment Risk Tolerance Assessment published on the web by the University of Missouri. It’s a quiz that asks you to make decisions for various hypothetical investing scenarios. At the end, it tells you whether your risk tolerance is high, above average, average, below average, or low.
Risk Tolerance Informs Asset Allocation
How can knowing your risk tolerance help your financial planning? It can help with asset allocation, for one thing. Asset allocation is the ratio of different types of investment in your portfolio. There are three broad categories of investments. In order of increasing risk, they are
- cash and cash equivalents: savings accounts, CDs, money market accounts, money in your mattress
- fixed income: bonds, annuities
- equities: stocks, exchange traded funds, mutual funds.
A high risk tolerance should incline you to increase the proportion of your investment in equities and reduce it in the other two categories. Some investors with a really high risk tolerance will even go outside the categories altogether and invest in precious metals, cryptocurrencies, or lottery tickets. (You can see a really high risk tolerance is not necessarily a good thing for investment success. A lottery ticket offers the possibility of very high reward, but the risk of loss is so high that it amounts to a near certainty.)
Many investment advisors use a rule of thumb for asset allocation: 100 minus your age equals the percentage you put into equities. Thus a person who is 20 should hold 80% stocks and 20% fixed income and cash. Note the rule of thumb changes your asset allocation as you age. It suggests you should become increasingly conservative as you get older. This is because aging reduces the amount of time you have available to recover in the case of recession or other loss-creating events.
Risk Tolerance and Your Financial Plan
I cite the rule of thumb just to offer you the conventional wisdom on asset allocation. Here at TB Group, we don’t use conventional wisdom. We consider a lot more than your age in developing our recommendations for your financial plan. We also look at your investing history, your family situation, your health and that of your loved ones, your prospects, your interests, your goals, your dreams, your values, and finally, your risk tolerance.
We aspire to give you better advice than Elon Musk gave his bankers. We believe a good financial plan isn’t just one that will make money for you. It’s one that you will feel good about following. It is an expression of who you are, who you want to be, and what your presence in this world will contribute to it. Not to sound too touchy-feely about the process, but we only make recommendations for your money after we know you and your vision of your future. Click here to set up your consultation with us.
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