Risk is a term we hear often in the investment world. But what does risk really mean and why is it such an important factor when developing an investment plan?
Let’s start by defining risk. In its simplest form, risk is the chance your investment will provide lower than expected returns or the possibility you’ll lose your entire investment. But let’s not forget why people invest in the first place. Investments are really just a means to achieving what’s important to you. Therefore a major risk with investing is that your investments won’t help you reach your financial goals.
So what does a financial advisor look for when assessing your tolerance for risk?
Goals and Time Horizon
Your time horizon refers to the amount of time in which you will be invested before your investment is liquidated. In other words, it’s the amount of time you’ve given yourself to achieve your goals. For example, if one of your goals is to fund your children or grandchildren’s education, and you expect to need those funds in 15 years, then 15 years is your time horizon. The longer your time horizon, the more risk you can afford to take.
Financial capacity refers to your financial ability to absorb losses. The more important it is for you to be able to buy or sell your assets quickly to meet your daily needs, the less financial capacity for risk you have.
People may struggle to separate their emotions from their investment decisions. Following a reactive cycle of excessive optimism when markets are up and fear when markets are down may lead investors to make poor decisions at the worst times. The more emotionally you respond to loss, the less risk you should take. For example, you should only invest in something like bitcoin (learn more here) if you are prepared to take a potential loss. The price fluctuates so much that if you make your investments subjectively you will experience many highs and lows.
Your time horizon, financial capacity and discipline guide the development of your investment plan. And as mentioned earlier, the main goal of your investment plan is to help you achieve your financial goals. You can’t have one without the other, so taking time to understand your risk is an important factor in having a successful investing experience.
Do you know how much risk you’re comfortable with?
At MPM Wealth Advisors, we use award winning technology that allows our advisors to pinpoint investors’ acceptable levels of risk tolerance in a simple risk number. Think of it as a sleep number for your investments. Our advisors use that number to help ensure investors’ portfolios align with their goals and expectations.
Discover your risk number by completing this five-minute questionnaire:
This information is for educational purposes only and should not be considered investment advice or an offer of any security for sale. Investing risks include loss of principal and fluctuating value.
About the Author
Working with a financial advisor may help simplify your financial picture and provide you with piece of mind.
Bryan Ohm is the co-founder and President of MPM Wealth Advisors. He has over 30 years of experience working with individuals, families and small businesses around the country to create clear, holistic and customized investment plans aimed at achieving his clients’ financial goals and lasting from generation to generation. Visit our website or give us a call (419-861-1400) to learn more about our full range of services. It doesn’t cost anything to explore whether MPM can add value to your financial picture.