When It Comes To Investing, How Much Risk Is Too Much?

This has been a nerve-jangling month for many investors. Still, not everyone reacts exactly the same to selloffs and bad news about the market. Risk tolerance is what makes the difference in how individual investors respond to market volatility. After all, investing is a mix between what you think will happen versus what you can actually tolerate happening.

Now may be a good time to revisit where you fall on the risk tolerance spectrum, and to ask yourself, “How much risk is too much for me?” 

You and I both know that if you had to choose the best place to invest your money over time (particularly when it comes to income generation), and you were looking at stocks, bonds, and cash, stocks would win this contest. Typically speaking and based on historical data, returns for stocks land in the 10% range, while bonds land around 5% and cash at 2%.

But, here’s the key – unless you have an iron-lined stomach, you likely choose to have a mix of these investment vehicles.  It doesn’t work to go all-in on stocks. Or to have big swings in your allocation to this asset class, like going from 80% to 0% stocks to 50% and then back to 0% before making it 70%. Doesn’t that feel exhausting just reading about it? Imagine doing it.

Let me share an example. Think of full-time hedge fund managers. They are in the business of managing higher-risk portfolios. These are actively traded, closely monitoring investment strategies that require day-to-day hands-on management and decision-making. And guess what? Even these folks can’t succeed with the back-and-forth “strategy” we outlined above.

While you may “know” that you should be 80% in stocks, or 60% in stocks, or whatever the number may be, if you go through a week like the one we just had and can’t sleep well at night, that’s your reality. And that’s okay. That’s a gut-check for where your risk tolerance is. And it’s important to know and remember. Maybe 50% in stocks is too much for you; maybe 40% is a better place for you to live.

Knowing where you lie on the risk tolerance spectrum is powerful information to have as an investor. It’s critical.

Remember to consider your time horizon, your goals, and your income. And, trust that over time, over the long haul or the very long haul, you can accomplish your objectives.

As a rule of thumb, there’s the 15/50 Stock Rule, which states that if you believe you have 15 years left on this planet, your portfolio should consist of at least 50% stocks, with the remaining balance in bonds and cash. The goal is to strike a constant balance between risk and reward. The stock allocation can be made up of either dividend-payers or growth stocks. You just need to keep an eye on your portfolio and reallocate as necessary to prevent stocks from creeping beyond the 50% mark.

Our bottom line here is that you shouldn’t expect to outsmart markets on a daily basis. Traders are the sprinters. You are a long-distance runner. Remember that time in the market beats out timing the market. Plus, it helps you sleep a heck of a lot better at night.

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