Perhaps the most important consideration when making investment decisions involves risk. However, what many people fail to realize is that not only can it be detrimental to their financial future to take too much risk, but it can also be detrimental to their financial future to not take enough risk. Largely, due to the bursting of the dot com bubble in 2000 and the subsequent financial crisis of 2008, many of today’s investors associate risk with emotional comfort level and, as such, primarily rely on cash savings or conservative investments to empower their financial future. However, what many of these investors fail to realize is that it could take a lifetime (or longer) to reach their financial goals in this fashion. Thus, even though they might tell themselves that they are taking little or no risk at all via the financial decisions they are making today they are, in fact, taking substantial risks in terms of empowering their financial future.
So, just what is the right balance between taking too much risk and not taking enough risk? This is a question that I frequently work with people to determine when coaching them on how to manage risk over the life of their investments. I do this in several ways to include:
A. Determining the risk category for each investment goal whether it’s a down payment for a home, an education fund, down payments for investment properties, or a retirement fund. The two primary considerations for determining the appropriate risk categories are:
(1) The defined amount needed upon reaching the investment goal (i.e., how do you know when the goal has been met?). To remain relevant, this amount may need to be adjusted over time. For example, when first establishing a financial goal for a down payment on a home you might initially estimate that you need $20,000 for this down payment, but later, due to home price increases and the type, size, and location of the home that you then desire you might discover that you actually need $30,000.
(2) How much money you presently have, how much money you still need to reach your latest adjusted goal, and what your time horizon is for reaching this goal. If, for a given investment goal, an analysis is performed and the determination made that it falls into a high risk category then you will need to invest in higher risk investments in order to meet this financial goal within your desired time frame. Otherwise it will take longer to reach this goal. The good news about being in a high risk category is that you do not have to be very precise in terms of market timing and/or the investment selected to progress towards the financial goal. On the other hand, if, for a given investment goal, this analysis is performed and a determination made that it falls into a low risk category than you will need to invest in lower risk investments to better ensure that you will not lose a significant portion of what you presently have should the markets experience significant declines. Otherwise, you run the risk, again, that it will take longer to reach this goal. In other words, it doesn’t make sense to take a lot of risk when you do not have to if you can meet this financial goal without taking this additional risk. The bad news about being in a low risk category is that you have to be much more precise in terms of not buying at the wrong time, or not buying the wrong investments, in order to sufficiently progress towards the financial goal. Unfortunately, as stated previously, many of today’s investors associate risk with emotional comfort level and thus rely on cash savings or conservative investments to empower their financial future. Furthermore, many of them have not even taken the steps to define what each of their investment goals are. If they did, they might be surprised at how long it might take to reach these investment goals by relying on cash savings and conservative investments. For example, if you had a total of $10,000 today, save an additional $2,000 per year plus a 5% increase for each future year, and invest all of this in emotionally comfortable conservative investments earning 3% a year, and plan to retire when you have a million dollars then it would take you 67 years to reach this retirement goal. Sixty seven years! However, it’s actually much worse than that. If you estimate that you might need $1,000,000 in today’s dollars to retire how much would that need to be 67 years from now? Well, assuming an average inflation rate of 2% per year, then your investment goal would need to be $3,800,000 dollars. So, although many of today’s investors invest in emotionally, comfortable, conservative investments what they do not realize is that they may not be able to reach their financial goals in their entire lifetimes! So, defining and refining their investment goals and re-evaluating progress and time frames are essential to ensure the appropriate investment risks are being taken. An investment which is emotionally comfortable today may not result in the gains needed to realize the investment goals within the desired timeframes. Recently, I coached a woman who wanted to retire in five years time, but was investing all of her money in a conservative bond fund. After performing some analyses we determined that her current savings would have to grow ten fold in order to reach her investment goal. Using an above average return rate of 8% per year it would take about 28 years or so to reach this goal. If she wanted to retire much sooner than that then the only chance she’d have of making it would be via high risk investments. Please do not wait until you are five years from reaching a major financial goal without understanding the appropriate level of risk to take to ensure your success. You don’t want to be forced into a high risk investment with little time to recover should the markets not cooperate. Making these assessments early on, and making adjustments and managing risk all along the way, is critical and will accelerate your progress towards reaching each of your financial goals.
B. Track and perform risk-reward assessments across various investment alternatives and invest in those which are appropriate with respect to the risk category associated with each investment goal. I perform risk-reward assessments based on various indicators and financial data that I regularly review and evaluate. I’ve discussed some of these via some of my previous articles: Using Bollinger Bands, Stochastics, and Other Indicators to Guide Stock Market Activities and Using Technical Indicators and Charts to Guide Stock Market Activities and Using Price Averaging to Manage Risk.
C. Invest in a disciplined fashion in accordance with the risk category associated with each investment goal using investment strategies appropriate for the risk category. I work with people to develop investment strategies in this fashion. One of the many strategies that I use is averaging into the stock pricing when buying and averaging out of the stock pricing when selling which is something that I discussed in one of my previous articles: Using Technical Indicators and Charts to Guide Stock Market Activities and Using Price Averaging to Manage Risk.
So, effectively managing risk and finding the right balance between taking too much risk and not taking enough risk, all along the way, is critical for empowering your financial future. Do not rely on cash savings and conservative investments if it will take nearly a lifetime (or longer) to reach your financial goals. Likewise, if you have made substantial progress towards reaching your financial goals, do not take so much risk that you stand to lose a large percentage of this progress if the markets significantly decline. I can help you to determine the right balance between these two extremes. And achieving the correct balance is critical if you hope to have the money you need to reach each of your future financial goals.
Managing risk and maintaining the correct balance of risk is key to progressing towards your financial future and the freedom that it brings. The impact of not doing this smartly is the same either way. If you do not take enough risk you will not reach your financial goals within your desired timeframes and if you take too much risk you will not reach your financial goals within your desired timeframes. The optimal level of risk to take at any given time is fluid and dependent upon your specific financial goal, the progress to date, and the associated timeframe. Any change to any one of these aspects will influence the level of risk appropriate for meeting the specified or refined financial goal within the specified or refined timeframe. Sticking to the same plan independent of these considerations will threaten your financial future and the financial freedom that it brings. I can help you to achieve this balance every step of the way.
This article informs how to manage risk and how to find the right balance between taking too much risk and not taking enough risk for each of your investment goals. Part of being a successful investor, and realizing consistent gains over time, involves managing risk and finding the right balance between these two extremes in a fluid, disciplined fashion over time.
For those that did not know, I generally perform life coaching and training services in two primary areas: 1) Personal and Professional Improvement, Development, and Growth, and 2) Financial Planning, Management, and Investing. As such, I generally alternate the articles that I write via my blogs between these two topic areas. This particular article is associated with the second area that I life coach in. So if you don’t have much interest in financial planning, management, and investing, rest assured that the next article that I write will be in the area that you might have greater interest in; the personal and professional improvement, development, and growth area.
Joseph M. Brennan Jr.
CEO/Life Coach – Brighter Days Life Coaching
“Your Brighter Days Life Coach for Life”
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