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Show Notes for this Episode:

What is personal risk tolerance

How well do you handle risk-taking? I’m not referring to risk in general here, like parachuting off of a cliff. I’m referring to risk in the context of your retirement nest egg or investment portfolio.

What personal risk tolerance means in the context of investing is how well you can tolerate the ups and downs. There really isn’t risk for permanent loss unless you sell out of everything at a low point in the markets.

The definition of personal investor risk is volatility. Volatility is just a fancy way of describing the “ups and downs” that occur in your investment portfolio over time. Your personal risk tolerance measures how well you can tolerate the investment experience as your nest egg fluctuates up and down.

There are more up days than down days in the markets, and recessions and bear markets come about once every 8 years on average. Your personal risk tolerance can help determine how you should be invested in order to stick with your strategy through any and all of the ups and downs.

Your personal risk tolerance can impact your investor behavior as well as your portfolio performance, and ultimately your retirement goals and lifestyle. The effect can be positive, negative, or even disastrous.

A risk tolerance lesson from the pandemic bear market

A recent article from the WSJ shared the results of a study done by Fidelity Investments. When they looked at how their investment customers behaved through the pandemic bear market, one-third of those 65+ sold all of their stock holdings between February and May. Nearly 20% of customers across all age ranges did the same.

It’s likely that most of these folks then missed the rapid rebound in the markets. The decline of 30%+ was rapid, and the rebound back to the upside was just as quick. So what now? When do they get back in? Do they invest a little at at time now or just put the whole chunk of change back in?

This is a game that nobody can win. Timing the market based on your emotions is not a strategy for achieving your retirement goals and sustaining your lifestyle in retirement.

Many investors who are over 50 fall into a mentality trap that says “I’m too close to retirement and therefore I can’t afford to take a hit now”. This is flawed thinking. This is your emotions talking. When you reach retirement, that doesn’t mean you take your retirement portfolio to cash and put it under the mattress.

What many fail to understand is that retirement is simply a new beginning. You have a very good chance of living another 30-40 years in retirement! Because of extended longevity (due to advances in healthcare and technology that will only continue), you will likely have many more years to sustain your income by keeping up with rising costs and taxes.

To and through retirement, you will need some allocation to stocks in your portfolio. Stocks have outperformed every other asset class over the long-term, and investing in them is what provides the growth you’re going to need throughout your retirement years.

How to assess your personal risk tolerance

In this episode I share I describe the different types of investment risk, including your risk comfort level (how much you are comfortable with) and your risk capacity (how much you really need to take to achieve your goals).

When I assess the risk tolerance of new clients to my firm, Sammons Wealth Management, I often find that their portfolios are invested more aggressively than they are comfortable with. This misalignment is what causes those big emotional investing mistakes that can impact your retirement. You want your retirement nest egg to be 100% aligned with your risk tolerance.

Fortunately we as financial advisors have come a long way in being able to accurately evaluate personal risk tolerance as well as the risk level of your investment portfolio.

I utilize a tool with my clients called Riskalyze. Riskalyze takes you through a short online questionnaire where you walk through a series of trade-offs to determine how much upside in your portfolio you are willing to give up for greater certainty on the downside.

I’ve been pretty amazed at how accurately Riskalyze assessed the risk tolerance of my clients, especially through this bear market we’ve experienced due to the Coronavirus pandemic. It does a great job of defining your ultimate pain point, which is that point where you almost can’t emotionally endure any further downside in your portfolio.

All of my clients have been able to stay invested and stick with their investment strategy through the pandemic bear market. Why? Their retirement nest egg portfolios are aligned with their personal risk tolerance. Yes, they experienced some downside, but they also received the benefit of the rapid rebound in the markets that followed.

Riskalyze is unique in that it gives you a risk number between 1 and 99 based on how you answer the questions, with one being the most conservative and 99 being the most aggressive. Once your personal risk tolerance is identified and assigned a number, you can see what to expect on the upside and downside with your portfolio over the next six months with a 95% probability.

Do you want to know what your personal risk number is? I’m offering my listeners and readers a chance to get their personal risk number for free utilizing my Riskalyze tool!

Click here to get your personal risk number

To get all the details on understanding how much risk to take with your retirement nest egg, listen to this episode of the Midlife Money Gal podcast:

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Welcome to the midlife money gal podcast. I'm Stephanie Sammons and experienced certified financial planner, guiding women professionals in midlife to, and through their retirement years. How well do you handle risk and what is risk anyway? What does it really mean when we talk about risk in the context of investing, that's what
we're going to be talking about today.

Now this is a really important topic because the more you learn about what your tolerance for risk is and how that compares to the way that your retirement nest egg is invested, the better off you will be. You will be able to align your portfolio with your risk tolerance and hopefully stick with your investment strategy long term. So what does risk really mean anyway? In the context of investing, you have a, a tolerance for risk and a capacity for risk, which I'll talk about what, what's the difference between those two in just a moment, but the risk that you take can impact your retirement goals, your nest egg and your retirement lifestyle. Ultimately, all of these things.

Now, most people, when they hear the word risk, they think about loss. And that's really not the kind of risk we are talking about.

When you experience risk in investing, there is no permanent loss, unless you decide to sell everything. When your chips are down, when the markets are down, you sell out, then you have lost some of your principle in your portfolio. But what risk really means in the context of investing is volatility. And that's just a fancy way of saying ups and downs, the ups and downs in the markets that we experience every single day. So when we talk about risk, we mean, what kind of experience can you handle with your investment portfolio on the journey to, and through retirement? What can you tolerate? So, as I said, there are two types of risk. The first type of risk is your risk tolerance, or I like to call it your risk, comfort level. What can you handle? What can you tolerate in terms of the short term ups and downs in your nest egg, in your portfolio, the second type of risk is capacity, risk, capacity.

What kind of risk do you need to take in order to achieve your goals and sustain your lifestyle throughout your entire retirement? And these are two different things because you may have a very low risk, comfort level when it comes to investing, but you may need to have a higher risk capacity in order to achieve your goals and sustain your income level throughout retirement. So there has to be some reconciliation of the two as you go through the process of determining what your risk really is, what your risk tolerance and capacity really is. And there is a very wide spectrum. There are stereotypes. So we used to just assume as financial advisors, that your risk was based on your age and how much longer you might live and how far away from retirement you might be. And so there's a stereotype that older people are more conservative.

They don't want to be as aggressive with their investments or set another way, hold more stocks than bonds in their portfolio. And the opposite of that is that the assumption or the stereotype used to be, if you're a young person, you're much more willing to be aggressive with your investment portfolio. And these are stereotypes. This is just not true. We have found that you could be 65 and older and be perfectly comfortable with 80% of your retirement portfolio in stocks and 20% in bonds, for example, and then the opposite being true for a young person. So it was important to figure out a way to accurately assess a client's risk or an investor's risk. Also, I've seen over the years, many people have this mentality, well, I'm only 10 years away from retirement and I afford to take another big hit. So they panic and they sell everything.

When we go through a bear market or a downturn in the markets. But what this fails to consider is longevity. You could live another 30 to 40 years in retirement and your time horizon for your retirement nest egg is probably a lot longer than you might think. It's not like you get to retirement and you stop investing and you pull everything out and you go put it under the mattress. If you do that, you will not be able to re sustain your retirement lifestyle because you will not be able to keep up with the cost of living prices. Go up over time. Taxes are a burden in retirement, or can be a burden in retirement. So you need some level of growth in your portfolio throughout your retirement years, in order to be able to generate the kind of income you will need to sustain your lifestyle and keep up with inflation and rising costs that happen over the years recently, an article came out from fidelity investments.

Actually it was in the wall street journal, and it was a study done by fidelity investments and fidelity looked across its entire base of investors. And they found that between the months of February and may of 2020 during very difficult bear market because of this pandemic, one third of people who are 65 and older sold everything, sold all their stock holdings. They completely got out and I'm guessing they had that mentality that I'm too close to retirement. I can't afford to take another hit. Right? Fidelity also found that nearly 20% of investors of all ages sold everything. They completely sold all of their stock holdings. They all missed the rebound because the rebound this time happened very, very quickly within a span of a very short time period. So now, what, what do you do if you're out, if you sold everything, when do you get back in, do you wait, do put a little bit back in at a time, or do you just put the whole chunk back in at one time, this is a game that nobody can win.

And this is why it's important to understand the kind of risk you can handle and make sure that your investment portfolio aligns with how you feel about risk and how much risk you really need to take to be able to achieve your retirement goals and sustain your lifestyle to, and through retirement. Sometimes our emotions do get the best of us. And if your risk level isn't accurate and you are invested incorrectly, this is the kind of thing that can happen. You might panic and sell everything or in an overvalued market, you might feel left out and you might feel like, gosh, the fear of missing out, I've got to get back in because I don't want to miss all of these potential gains. And he might buy at the wrong time.

The key is really having that accurate balance, that right balance. And we call that your, your asset allocation, your split between stocks, bonds, and cash, so that you can really stick with the strategy and stay invested no matter what kind of market environment or economic situation we are in. So how do you know that you have the right risk level, or how do you even understand what level of risk is appropriate for you with your retirement assets? Fortunately, a lot of work has been done in this area and there are tools available that can help you assess your risk. My favorite tool is called Riskalyze and Riskalyze is a software tool that is available to financial advisors, financial planners, like myself, that we are then able to utilize with our clients. Now, Riskalyze has put a tremendous amount of research and testing into their tool, and I really love their methodology. And I love how they look at assets and pricing and portfolios. It just makes sense to me the way that they go about assessing and identifying someone's risk.

Okay.

So what

They do is through a series of questions you are able to then at the end of the assessment, receive your personal risk number and your personal risk number can range between one and 99. One being the most conservative and 99 being the most aggressive risk. Now, I really saw the benefit of this tool play out during this recent bear market that we experienced when the overall markets were down, that the S and P 500, which is a proxy for the market was down 34%, 34, 35% for the low at the bottom. Okay.

And remember, you're likely not going to have a hundred percent of your portfolio and stocks, which means you probably would not have experienced that level of decline. That temporary downside decline was probably less than that. Assuming you have a mix of stocks, bonds, and cash in your investment portfolio, but I was amazed at how accurate this software assessed my clients. And it really helped to uncover what their pain point was. And that pain point is like, when you almost can't stand to see your accounts go any lower, but you're not willing to give up. You're not willing to throw in the towel. You're not willing to sell everything. And to me, that is just priceless. So the tool is very good at identifying how much risk you can tolerate, how much pain can you take. And it is painful to get through the short term down markets. And that's the price we pay for higher returns in owning stocks over the long run stocks out, perform everything else over the longterm.

Okay.

There are more appears than down years. Recessions happen on average once every eight years. So you're going to experience those downturns. We're going to have events that happen that are exotic venous events like this pandemic that are outlier events. Other ones include nine 11 and the financial system crashing in 2009. We called that the great recession. And so Riskalyze does not specifically account for these outlier events when they are assessing your risk, but they still come into play in terms of your overall risk, capacity and risks, risk tolerance. In other words, you have to be able to get through those tough times, regardless of what your risk number turns out to be. But the assessment of what that number is, is incredibly accurate and a very good indicator of how you will behave when you go through the difficult times in the markets.

All right. So with this tool, Riskalyze, I'm going to talk about it for just a minute so that you understand it. It can give you your personal risk number between one and 99. It can assess what risk number your current portfolio is. And you can also plug in an alternate portfolio that matches up better with your risk number. So a lot of times with a new client, we will look at their current portfolio and how it is invested and assign it a risk number based on the holdings inside of that portfolio. And then I'll have the client go through the risk assessment to determine what their personal risk number is. And nine times out of 10, the two things don't match up. Most of the time, the client is invested more aggressively than what their risk number says than what they're able to tolerate. So it's a really good opportunity for me to get the portfolio more in line with the client's goals and tolerance and capacity for risk, so that they are able to stick with the strategy and whether any future storms.

So to get this risk number, you go through the short questionnaire where you choose between tradeoffs or risk reward type scenarios. And what you're choosing between is your comfort zone and sacrificing some potential upside growth in your retirement nest egg for more certainty. So the tool is trying to understand how much are you willing to give up on the upside in order to protect the downside of your nest egg. And it's a really deep dive into your psyche around how you feel about risk in relation to your portfolio. So let me just give you a simple example of the kinds of questions you might see in this assessment. And I'll use a hundred thousand dollars because it's a round number and it's just easy math. So you might get the question for a chance of gaining $25,000 on your hundred thousand. Are you comfortable risking or experiencing a $15,000 decline? Are you willing to take enough risk where you can get a 25% return

Or, okay,

You might see a negative 15% return down 15,000 temporarily with this kind of risk number. And it goes through a series of questions like this, to figure out exactly what you're comfortable giving up on the upside in order to protect the downside, how much downside pain can you take over the short term? And then they further refine this through additional questions that through the process, and then at the end, you get that tangible risk number that we can then use in a variety of scenarios to determine how you should be invested based on your goals, based on what kind of lifestyle you want to have in retirement, based on your resources, your income, your age, et cetera. We look at all these different factors, not just your risk tolerance. Okay. All right. So then once we know your risks score, we can build from there.

And the ultimate goal is for you to have an investment portfolio and an investment experience that allows you to sleep comfortably at night and stay invested through all the ups and downs and stick with your investment strategy. And I'll also say that you might be really surprised at how you score in this risk assessment. I've had clients who thought they would come out very conservative Lee, and they ended up being a lot more aggressive in terms of what they felt like they could handle or tolerate. And so it's important once someone does understand what the risk number is, it's important to have a discussion about it, just to make sure that you completely understand what the questions were asking and that you are comfortable with the number that you get.

It's critical to get this right, your tolerance for risk, especially if you are a closer to retirement, if you are within 15 years or less, you've got to get this right. Otherwise you might make a big mistake with your retirement nest egg, and that can have really a disastrous impact on your retirement lifestyle. So it's better to be invested in a way that you can stick with a strategy and sleep at night. And that's what uncovering your tolerance for risk is all about. Now. Riskalyze is not the only tool out there in the world. There are others, but I have kicked the tires on most of them. And this is by far my favorite tool of choice. So I'm going to lay out an offer for you, my listeners, if you want to find out what your risk number is, I'm going to for a temporary time, offer you a free risk number assessment, and you can understand exactly what your risk number is.

And if you want to take it a step further, we can also look at the risk number associated with your current investment or retirement portfolio. So to take advantage of this free risk number assessment, you can go to midlife money, gal.com forward slash risk, just the word risk, midlife money, gal.com forward slash risk. You'll see a button on that page that you can click, and that will take you into the questionnaire. It's very short. It will take you no more than five minutes to go through. And then once you're done, I will get a notification and I will be able to send you your personalized risk number report. So you'll have it. And you can use that. However, you wish maybe you are working with a financial advisor and you want to take that to your financial advisor and see how it stacks up against how you are currently invested, or I can help you assess your current investment portfolio and see how wide the disparity is between what your risk number says and the risk number of your current portfolio.

So that's how it works, but you don't have to do all of that. You can just go figure out what your risk number is, and the report will give you some pretty good information about what you can expect realistically, over the next six months to see in terms of the ups and the downs, if you were invested at that risk number, it will tell you what you can actually tolerate. All right, that about wraps up this risk discussion. I hope you find it helpful to you and understanding more about why risk and understanding risk is so important. And if you have any questions as always, you can reach out to me at Stephanie

At midlife money, gal.com. Thanks again for listening. And I'll see you next time. This show is for informational and educational purposes only. Please do not consider any of the content as personalized financial investment tax or legal advice. You've been listening to the midlife money gal podcast to learn more and to join our community, visit midlife Lenny gal

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