By Bob Brooks
March 5, 2015
When it comes to investment risk, people take it for all types of reasons. Some of them make sense while others don’t. Some take it and have no idea that they are taking it. This is one of the reasons why I have offered my risk survey as a free resource. I am on a mission to help people understand risk. I believe it is one of the most misunderstood concepts in investing. So, make sure that you take advantage of this free resource.
Here are the three most dangerous reasons to take risk.
- Trying to play catch up – You are behind in your saving for retirement and you are being as aggressive as possible to make up for lost time. It is understandable. If there is a possibility to get caught up you want to take that risk. So, be as aggressive as possible, right? There is one overriding problem with that reason. Most people will be so busy focusing on being aggressive to make higher returns that they will not do anything to protect themselves from risk. Thus, their investment plan becomes no different than high stakes poker. If you are going to be aggressive, you have to plan for risk. A growth only strategy will put you on the investment roller coaster at best.
You are young – This is a rationalization that has been fostered by the mutual fund industry. You are young and can afford to take risk because you have time on your side. In fact, the mutual fund industry has developed a whole like of mutual funds that base the amount of risk that you take on your age. In theory, as you age the fund you are in decreases risk level. Maybe you are 25 years of age and taking a lot of risk is not a fit for you. If so, take the level that is appropriate versus going all in because you have “time on your side.” There is more to it then age when assessing a risk level.
Because my advisor recommended that I do – Are you and your advisor on the same page in regards to risk? The initial conversation usually goes like this.
Advisor: On a scale from 1 to 10, what is your risk level?
Client: I am a 6.
Advisor: Great – then let’s look at putting together a portfolio that resembles a 6.
Do you know what a 6 is? There is no commonly accepted definition for any of the numbers between 1 and 10. Chances are what you think is a 6 and what your advisor thinks is a 6 are two different things. Get on the same page with your advisor and have a very well thought out conversation about risk. This is a conversation that the advisor should take seriously. If not, maybe you need a new one.
There is a formula for taking risk. The formula is involves risk and reward. You take more risk when the likelihood exists that you will get more reward. You take less risk when you feel there is a likelihood exists when you will get less reward.