Episode #21- Does Your Portfolio Fit You?

Wealth Decisions Podcast Transcript for Episode #21- Does Your Portfolio Fit You?

Listen to this episode on Apple Podcasts or Spotify

In today's episode, we're going to be talking about does your portfolio fit you?

How do you determine the right mix of investments for your stage in life and risk tolerance?

Now, whether you're just starting your investment journey or you've maybe been managing things on your own for a while, and want to reassess your strategy, understanding your risk tolerance is the key to building a portfolio that aligns with your financial goals and really just helps you sleep soundly at night.

So in today's episode, we're going to talk about what investment risk really means.

We're going to talk about the factors that influence your personal risk tolerance.

We're going to talk about different types of investment risks.

We're going to talk about strategies for assessing your risk tolerance.

And lastly, we're going to talk about how to align your investments with your particular risk tolerance.

So let's first talk about what investment risk really means.

You know, when we talk about risk in investing, we're really just talking about the possibility of losing money or not achieving our expected returns.

It's important to understand, though, that risk isn't inherently bad.

It's a natural part of investing.

And generally, higher risk investments offer the potential for higher returns.

You have to kind of think of risk as a spectrum.

You know, on one end, you have very low-risk investments like savings accounts or money market accounts or government bonds.

They offer typically minimal returns, but also minimal risk of losing your principal.

On the other end of the spectrum is high-risk investments like speculative stocks or cryptocurrencies, which can offer potentially big returns, but also carry a significant risk of loss.

The key is finding the right balance for you, which brings us to our next topic, and that's the factors that influence your risk tolerance.

Your risk tolerance is highly personal, and it can be influenced by a number of factors.

Number one, your age and your time horizon.

Generally, younger investors can afford to take on more risk because they have more time to recover from potential losses.

As you approach retirement, though, you may want to shift toward lower risk investments for part of your portfolio to protect the wealth that you've built so far.

A second factor can be your financial goals.

Are you saving for a short-term goal like a down payment on a house or a long-term goal like retirement?

Short-term goals usually require a more conservative approach, while long-term goals can often withstand more risk.

You also need to look at your income and job security.

If you have a stable job with a steady income, you might be more comfortable taking on higher investment risk.

On the other hand, if your income is variable or your job is less secure, you might prefer a more conservative approach.

A fourth factor would be your overall financial situation.

That includes factors like your savings and your debt levels and other assets.

The more financial cushion that you have, the more risk you might be able to tolerate with your investments.

It also comes down to emotional comfort.

Some people simply feel more comfortable taking on risk than others.

It's really just crucial to be honest with yourself about how you'd react to significant market downturns or volatility.

That comes back to that sleep at night type of portfolio.

It also comes down to your knowledge and experience.

The more you understand all the rules of investing and the different various types of investments that you can own, the more comfortable you might be with taking more calculated risks.

Now let's talk a little bit about the different types of investment risks that you'll encounter when investing.

Number one is market risk.

This is the risk that the overall market will possibly decline, affecting the value of your investments.

And market risk is influenced by economic factors, can be influenced by geopolitical events, or just general changes in investor sentiment.

The second type of investment risk is interest rate risk.

This primarily affects bonds and other fixed income investments.

When interest rates rise, bond prices typically fall and vice versa.

But interest rates can also impact the stock market, like we've seen over the years.

When the Fed gets involved and they start raising interest rates, that can typically negatively impact the stock market.

But on the other side, when the Fed is lowering interest rates, it can typically benefit the markets, because companies can borrow money at lower interest rates to fund operations.

Some more goes to the bottom line for those companies.

The third type of investment risk is inflation risk.

This is the risk that your investment returns won't keep pace with inflation.

This is particularly relevant for more conservative investments like savings accounts or money market accounts or low interest rate bonds.

The fourth type of risk is liquidity risk.

This kind of refers to how easily you can convert your investments into cash without a significant loss.

Some investments like real estate or certain types of bonds can be harder to sell quickly.

The fifth type of investment risk is company specific risk.

This is typically associated with investing in individual stocks.

It can be factors like management decisions or product failures or other issues unique to that company.

The sixth type of risk is currency risk.

If you're going to invest internationally, changes in exchange rates can impact your returns.

The seventh type of investment risk is political or regulatory risk.

Changes in government policies or regulations can impact certain industries in our economy.

So investing in really anything involves some type of risk.

And those types of risks are just something that you need to understand when investing.

So let's talk a little bit about some strategies for assessing your risk tolerance.

There's risk tolerance questionnaires.

I use a service by Nitrogen Wealth called Riskalyze.

A lot of financial institutions offer some type of risk tolerance questionnaire.

And they'll typically ask you about your goals and your time horizon and how you'd react to various market scenarios.

But there's another test that I call the sleep test.

Ask yourself if your investment portfolio were to drop 20% in a month, would you lose sleep over it?

If the answer is yes, you might need to dial back your risk.

You can also kind of look at your past behavior and reflect on how you've reacted to market volatility in the past.

If we had a big downturn in the market, did you panic and sell during those downturns or did you stay the course?

So whether you're just starting investing or you've been investing for a while, if you are just starting investing, start small.

If you're unsure, start with a more conservative portfolio and gradually increase your risk exposure as you become more comfortable with investing.

And definitely consult a financial advisor that has been helping people invest their money for retirement for many, many years.

They'll be able to help assess your risk tolerance, but also your risk capacity, what type of risk that you can handle and what type of risk level you should be at for your stage in life and your financial goals.

You know, risk tolerance isn't set in stone.

It's going to change over time as you get closer and closer to retirement.

So let's go back to the question of this podcast.

Does your portfolio fit you?

When I have clients fill out the risk tolerance questionnaire by Riskalyze, it assigns a speed limit score called the risk number.

And whatever that number is determines the type of asset allocation that particular client should have for their stage in life.

So asset allocation is one of the most crucial parts of investing.

And that's dividing your investments among different asset classes like stocks, bonds and cash.

Next is looking at diversifying that portfolio into different sectors, into different geographic regions, and also making sure we have exposure to small caps, mid caps, and large caps, both growth and value type approaches.

And typically the best way to build a portfolio today is using a combination of low cost index funds and ETFs and some actively managed mutual funds in certain categories where portfolio managers have proven to add value.

And ETFs are the most popular way to invest today because they're very low cost ways to get exposure to certain parts of the market.

ETF stands for Exchange Traded Fund.

They trade just like a stock throughout the day, and you can buy an ETF in pretty much every sector of the economy.

As well as small cap and mid cap and value and blend and growth and large cap.

And then you may consider investing some of your portfolio in individual stocks.

I like to see people have a base of good quality, low cost index funds and ETFs before they start venturing into individual stocks for their portfolio.

But if you're going to invest in stocks, you need to have a process for picking stocks.

And you need to be diversified in many different industries to make sure you mitigate some of the risks of being too concentrated.

It all comes down to your comfort level.

And if you've never invested before, using just a broad selection of good quality, low cost ETFs is the best way to get the most diversification.

Once you build a base, individual stocks can be a great part to build your wealth over time.

And once you have a solid portfolio in place, it's not a crockpot.

It's not a set it and forget it.

You want to constantly monitor that portfolio.

You want to rebalance it from time to time to make sure it's at the right level of risk for your stage in life and risk tolerance.

You want to add to that portfolio by dollar cost averaging.

Maybe you select two or three of the ETFs that you have that you can add to on a monthly basis to take advantage of the ups and downs of the market.

The goal isn't to eliminate risk entirely.

You can't do that.

Diversification is super important, but you're not going to mitigate risk completely.

But it's to manage it in a way that aligns with your financial goals and your personal comfort level at this point in your life.

So understanding and managing investment risk is a crucial part of your financial journey.

By assessing your personal risk tolerance, understanding different types of risk, and aligning your investments accordingly, you can create a portfolio that helps you achieve your financial goals while still allowing you to hopefully sleep at night soundly.

So that's it for today's episode.

Does your portfolio fit you?

And if you like this episode, please rate the episode, make some comments, and hit the notification bell to get updated on future Wealth Decision Podcasts.

Listen to this episode on Apple Podcasts or Spotify


-Brian D. Muller, AAMS® Founder, Wealth Advisor

Momentous Wealth Advisors in a fee-only fiduciary advisory firm

Disclaimer: This material is for informational purposes only and should not be construed as investment advice. Past performance is not indicative of future results. Investors should make investment decisions based on their unique investment objectives and financial situation. While the information is believed to be accurate, it is not guaranteed and is subject to change without notice.

Investors should understand the risks involved in owning investments, including interest rate risk, credit risk and market risk. The value of investments fluctuates and investors can lose some or all of their principal.

Always consult with a qualified financial professional before making any investment decisions.