Easy Money: How Much Risk are you Taking?
How much actual money is at risk in your portfolio? When clients come in, a lot of times they’ll say, “Okay, I want to take 10 or 15 or 20% risk in my portfolio.” And I’ll step back and say, “Okay, well, let’s actually make sure you understand what that is.” Because 10 or 15 or 20% sounds like a pretty small number. A lot of times people say, “Yeah, I’m fine with it”, they might even say 30 or 40% because just in our brains, it doesn’t sound that bad. But when you actually step back and apply it to your portfolio, how much risk are you actually taking?
What I like to do is quantify instead of qualifying. I know those are big words, but qualifying risk is ranking on a scale from 1 to 10, how much risk do you want to take? You might even see risk numbers on a scale from 1 to 100, and while you can use these metrics, you still need to make sure that you have quantified the amount of risk that you’re taking. For instance, if you have a $200,000 portfolio and your risk is, worst case scenario, 15%, you’re talking about $30,000 of potential loss. Are you okay with that? Maybe you are and maybe you aren’t.
Now remember, I’m not saying that risk is terrible, because you need to take some risk if you want to grow your money more than what fixed interest rates are. That’s fine, but you really have to know how much you could possibly be risking. For one of my exercises I like to say, “Okay, based on your current portfolio or the portfolio that we’re going into, this is what it would have done in 2008.” That’s one of the worst years we’ve ever had, so it’s a pretty good basis for recommendations. “If in 2008 that account would have lost $30,000, are you okay with that?”
A lot of times, people will say, “Well, yeah, but that was an anomaly. That’s never going to happen again.” One out of every five years, we have a downturn in the market of up to 20%, so it’s not an anomaly. It’s going to happen in your lifetime. If you’re investing for 20 – 50 years, there’s going to be a point when your investments are down between 20% – 50% if you’re invested in equities. So just know what that risk is and make sure you’re comfortable with it.
In summary, what you want to do is look at historically what the worst years of your investments are or were and apply that to how much you have invested. If you have $100,000 invested and in 2008, that account went down by 35%, well, that’s $35,000. Are you okay with that? If you’re working with a financial advisor, they should pretty easily be able to tell you exactly how much risk you’re taking. Remember, quantify. Get that actual number in your head and make sure you’re okay with it, not just the concept of on a scale from 1 to 10 or not just a small percentage number. Actually get the quantifying factors in there and make sure you know what amount of risk you’re taking.
Securities and advisory services offered through Madison Avenue Securities, LLC, member FINRA SIPC, and a registered investment advisor. Madison Avenue Securities, and Don Anders are not affiliated companies.