I had an interesting conversation earlier this week regarding our risk tolerance in our investment portfolios. I was surprised to see my family member had taken on much more risk in his portfolio than me, and he had over 20 years on me.
He was approaching retirement in his field and had already reached his F.I.R.E goal. That is the target amount of money needed to retire according to his needs. But a large portion of his investments were in individual stocks, most of which were a bit risky.
My family member had money invested in SPACS, lots in Tesla and many more. Let’s just say he was just as surprised to hear 93% of my stock portfolio was in index funds. I’m not claiming to be a professional investor, but I’m happy with where my money is invested.
But that begs the question. How much risk is too much risk? Should I be taking on more risk in my portfolio? It’s often hard to find a good balance between an aggressive portfolio and more conservative, especially as many new investors look at investing as gambling.
Establish Goals
First, it’s important to establish your goals. Why are you investing? Are you saving for retirement or maybe to build financial independence?
Figuring out your goals for investing can be difficult. You could have multiple goals or just like growing your money. That’s totally okay too, just understand your reasons for investing and you can go from there.
Understanding how much risk you can take can be based on what your goals are, but we also need to know one more thing, which leads to the next section.
Determine Time Frames
We know our investing goals, but what does the time frame look like? If you’re saving for retirement, you probably have a little longer. That is if you’re younger and have quite some time under you hit retirement age (excluding early retirees).
Look at your goals and determine how long it will take to reach those goals. The further away your goal is, the more risk you can take. I have a target date fund for my retirement account, which automatically adjusts risk levels as I get older and closer to my target retirement.
If your goal is coming up soon, it may be a good idea to keep the risk low, so you don’t lose money. I’m sure you would hate to withdrawal your money when it’s time only to discover it’s less than what you initially invested.
Understand What You’re Comfortable With
You know your goals and the time frames for each, but another factor to consider is what you’re comfortable with. Taking on too much risk can be stressful, especially if you’re going to constantly monitor your portfolio.
Throwing a large chunk of money into Tesla or some other individual stock is not guaranteed to succeed long term and carries with it a large risk, but if that’s what you want to do, go for it.
Please don’t do that, but you know what I mean. I recommend building up a solid foundation in your portfolio of index funds and sprinkle in some individual stocks you believe in.
I lean more conservative in my investments than others because I don’t know if the money my wife and I are making will suddenly just stop. That’s the risk with being self-employed, so we are investing heavily, but in stocks/index funds we know will continue to grow our money in the long term.
We can’t take the chance to be too risky with our strategies. Besides, all of our risk is found in our crypto portfolio. I have a good amount of money invested in Bitcoin and Ethereum, so that’s all the risk I really need.
Final Thoughts
Everyone has their own risk tolerance. Whatever your goals are or whatever your preference is, understand the amount of risk you can handle. You can always adjust it according to new timeframes or goals. Recalibrating your portfolio allocations is a normal thing to do quarterly or even just annually.
Please don’t gamble all your money away on some crazy new stock everyone is talking about. I promise you these kids don’t know what they’re talking about. Even if their account has a lot of money in it, it’s not worth it.
I recommend building up the foundation of your portfolio around index funds, then find a small percentage of companies you believe in and see a future with and invest the rest of your money in them. My main brokerage has about 90% in index funds and the remaining 10% is in individual stocks like Amazon, Tesla and Apple.
