Risk tolerance is a measure of how much fluctuation in value you can stand in order to receive growth of your principal over time. Sound simple, right? Or maybe is just sounds like financial mumbo jumbo.
The term risk tolerance is used to help understand how comfortable a client is with fluctuation in their account value. We know that everybody wants their investments to grow. We also know that nobody likes it when they see RED numbers on a statement showing that the value of their account is down. So, as a financial planner, I need to understand your goals for this investment. Particularly two factors:
- How much do you need this investment to grow?
- How much time do you have before you need the spend the money?
So, if you need the money to double in order to meet an important goal, that gives us a target.
If you need the money to double in 10 years, then we know that you need to average 7.2% each year to get there. Which means that we need to talk about investing in growth stocks. And we need to talk about how much fluctuation you should expect along the way.
You see, we know that stocks of quality U.S. companies have averaged 10.86% with dividends reinvested each year for the last 100 years. While bonds issued by quality U.S. companies have averaged 6.85% per year since 1976. (Source: Bloomberg US Agg Bond index.) So, if you want more growth, you need more stocks.
But the prices of stocks fluctuate more than the prices of bonds. So, to get the growth you need to be prepared for routine fluctuations in price.
For example, the chart below shows that the S & P 500 index has averaged 12% total return with dividends reinvested from 1980 to the end of July 2021. AND it shows the average drop in price during each calendar year was 14.3% - each year – and at the same time posted positive returns in 31 of 41 years.
Statistically, if you owned the S&P 500 index, you would expect your money to double in 6 or 7 years. And you can expect that if you look at your statements once per year you will see growth three years out of four. But if you look at your statements daily, you will expect to see your account value down about 46% of the time.
So, risk tolerance tells you how steadfast you will be when you have seen negative values for days 8 times in a row. It can be hard to keep your faith in the face of negative returns. This is where the advice of a well-trained, experienced, fiduciary financial planner like a can be super helpful. A good advisor will provide perspective and advice to get the growth you need without suffering unnecessary volatility.
If you would like to get an idea of YOUR RISK APPETITE follow this LINK to take a quiz that will show you. And I’m happy to talk with you about your Risk Tolerance and help you make a plan that fits your personal style. Follow this LINK to find a time for us to talk.
If you want to talk with a CFP® professional near you, start your search here.
As you visit with financial planners, I suggest a couple things to check:
- Is the advisor always the client’s advocate – a fiduciary advisor?
- Is the advisor paid by clients, not financial product manufacturer or distribution network? That would be a fee-first advisor.
These two points help assure that you are working with a professional who is committed to your best interest at all times. It seems sort of obvious to me that a professional would work in this way, but it’s not automatic.
A fiduciary, fee-first, CFP® professional can help you make great retirement income choices and develop a comprehensive financial plan that is driven by your goals and priorities and addresses all aspects of your financial life. With a big-picture approach, you will be better prepared to understand your options at every step along the way.
Yes, I am a CFP® professional. I’m always a fiduciary and I work on a fee basis. And yes, I’m still taking on a few great families to be part of my financial planning practice.
If this article has you thinking about your own circumstances, contact my office at rdunn@dunncreekadvisors.com. I am always happy to meet with people who are working on their retirement plans. Dunncreek Advisors does not provide legal or tax advice, nor is this article intended to do so.