Your risk tolerance -- Does it work for you or against you?

​BY JULIA ANDERSON
Futures contracts are beyond my investment expertise.
Neither do I understand “puts” and “calls.”  Nor do I care to buy gold, collectibles, artwork or limited partnerships in the hope that their values will increase. Annuities make me nervous.
 
For me, these investment options for my retirement savings are too risky even though their promised payout might be tempting.
 
On the other hand, if I put money into U.S. Treasury bonds or into a bank savings account insured by the federal government, it would be secure. No risk there.
 
I am an investor in the middle trying to balance risk against a reasonable investment reward.
 
For me that means investing in high-grade blue-chip dividend-paying common stock in U.S.-based corporations and in low-fee growth U.S.-based mutual funds such as a S&P 500 Index Fund.
 
Bottom line: I am willing to endure a future economic downturn and accompanying stock market sell off because history shows that the American economy is resilient and will recover. Over the past 75 years, U.S. markets have averaged 10 percent annual growth. To benefit as an investor, I must take on moderate risk to ensure my long-term financial future.
 
Determining your RISK TOLERANCE is an important but often over-looked aspect of investing. However, risk tolerance is among the first things an investment adviser will ask you about. Be prepared with an informed answer.
 
Too many investors (especially woman) get off track because of their response to the risk tolerance question. “No, I don’t want to see the value of my investments ever go down,” they say. “No, I can’t stand the idea of ever losing money.”
 
During a recent Women & Money workshop, a woman in the audience lamented to me that her husband was in charge of their retirement investments and that “he does not trust the stock market. All our money is in bank CDs,” she said.
 
I told her that strategy was OK in terms of no risk but that she and her husband were likely getting a 1 percent or less return on their savings over the past 10 years. That’s while U.S. stock markets delivered annual average gains (share price increases and dividends reinvestment) of 17 percent. That means a $10,000 stock investment 10 years ago would now be worth $48,068.
 
She left the presentation upset. I doubt she will have any success convincing her husband that his savings and investment strategy is too conservative. I didn’t have the heart to tell her that they are losing money on their “safe” CDs investments because inflation (the rising cost of living) is eating into the purchasing power of their nest egg.
 
People --both men and women -- get nervous when markets are volatile (as they are now at the beginning of 2020) and there’s more talk about the next recession.  Our bull market can’t go on forever, right?
 
Preparing for a recession
 
How should we plan for a downturn? Where should they put their money? In bonds, stocks, the bank or under a mattress? The risk factor is becoming more importance.
 
Burton Malkiel, author of the famous investing book, “A Random Walk Down Wall Street,” wrote a piece for the Wall Street Journal recently (Dec. 2019) that offers these suggestions:
 

1. Stay diversified. Make sure your money is invested in a range of holdings from safe assets (cash or Treasury bills) to higher dividend stocks and funds.
2. Rebalance your portfolio, if needed. Rebalancing reduces risk. Don’t let any one stock or investment become too big as a percentage of your portfolio.
3. Harvest tax losses. Keep fund management fees and investment costs to a minimum. Malkiel recommends low-cost or zero-cost index funds.
4. Stay focused. Rarely, can you predict stock market ups or downs, especially in the short-term. The “idea that you are going to get ahead of the curve or the crowd, is dangerous,” he said in an interview. “Buy and hold is not dead. No one knows how to time the market” by jumping in and out.

 
Back to the risk factor. In his book, Malkiel makes a case for taking on moderate risk. He points out that the return on a portfolio of U.S. common stocks has averaged 10.5 percent a year over the past 25 years or so. Your portfolio with reinvested dividends (at 10 percent) should double every seven years!
 
Further, he suggests that your capacity for risk is usually related to your age. The younger you are the more risk you can take on because time is on your side and you have many working years ahead of you to accommodate market downturns. A higher-risk portfolio of smaller growth stocks might be appropriate, he said. 
 
If you’re on your 60s, facing retirement with less income, a portfolio of safer investments makes sense. Bonds and high-dividend stocks could be the solution. Bank CDs still may not be the answer because your savings have got to generate some income. 
 
“The longer you can hold on to your investments, the greater should be the share of common stock in your portfolio,” Malkiel states. “Moreover, the longer an individual’s investment horizon, the more likely it is that stocks will outperform bonds.” (here's a link to a 2010 Malkiel lecture the continues to have merit, click here.)
 
(The Internet offers numerous calculators that will determine the return on investment with compound interest (dividends) and savings contributions. Here's one, click here.
 
My tips on managing RISK:
 1. Be informed. Read Malkiel’s book, “A Random Walk Down Wall Street.” or at least read the parts that are relevant to your age and financial situation. Go online and watch his investment lectures on YouTube. Click here.

 2. Understand that downturns are normal and part of the trade-off between risk and financial reward. Don’t sell during a downturn. Don’t expect to jump back in before markets go up. 

 3. A higher rate of return typically means taking on more risk. Don’t invest in stuff you don’t understand, even if you are guaranteed a high return. There is no free lunch. And realize that short-term fluctuations in markets can be scary. Don’t panic, stay the course.

  4. Realize that it doesn’t have to be all or nothing.
or me, a return of 2 to 4 percent a year on an investment is reasonable. Most of my investment portfolio generates dividends in the 2 to 3 percent range, plus whatever happens to the value of the stock. I continue to reinvest dividends paid inside my tax deferred IRA even as I know must take the Required Minimum Withdrawals.  I have enough in cash to cover RMDs for a year That way, I’m prepared for a downturn and won’t have to sell principal at a lower price. 

 5.  You don’t have to be a stock picker. Managing risk might mean investing in a low-cost index fund tied to the S&P 500 or a broad mix of a sectors such as telecom, high-tech or industrials. Look at the track record for the funds you buy and be sure to check out any management fees that can eat into your return.

 6. Save and invest even in bad times. Make saving AND INVESTING  a regular part of your long-term financial strategy.   
 
For more:
​YouTube - What is investment risk?, click here. 
“A Random Walk Down Wall Street, “by Burton Malkiel, click here
"A Way to secure retirement income later in life," click here.
The Risk of Different Types of Investments, click here.
Saving and investment options, usa.gov, click here
 Risk Management and You, Edward Jones, click here.