Episode #19: Know That Buzzword: Risk Tolerance

Today’s Prep:

Understanding risk tolerance and what it means in your portfolio is crucial to building the right plan for you. But what in the world is risk tolerance? David walks us through this financial buzzword so you can create a portfolio that suits you and your risk tolerance appropriately.

(Click the featured times below to jump forward in the episode)

Equipping Points:

[2:44] – How Do You Describe Risk Tolerance?

  • People get happy when markets and portfolios are going up, but they become angry and irrational when they are going down. People like to make money but hate to lose it. Risk tolerance is knowing how a client will react to a down market.

[3:46] – How Do You Determine Someone’s Risk Tolerance?

  • There’s a questionnaire we have that helps document someone’s risk tolerance. But I also try to ask a lot of open-ended questions and listen to the answers. I ask questions such as, “What types of investments have you liked in the past?” Or “How did you react to what your portfolio did in 2008-2009?” How a person actually reacts is a lot more important than what they say they will do the next time.

[4:58] – Does Risk Tolerance Factor Into Your Plan?

  • Determining a client’s risk tolerance is an important first step in the planning process. I want to make sure to structure a portfolio that’s fit to a person’s risk tolerance. That way when the market corrects, they don’t do something silly. Every investment has risk. Even banks and annuities have risk (i.e. People are disappointed when their investments don’t grow). Stocks and bonds risk losing capital when the market goes down. My job is to size the portfolio based on the risk tolerance of the person.

[6:50] – What’s Normal? Do Most People Have A Similar Risk Tolerance?

  • People are all over the map. Most people don’t really have a good idea of how much risk is in their portfolio. Looking at past down markets and how someone reacts is really telling. Everybody loves a rising market, but how are you going to react in a down market?

[8:45] – What’s An Example Of A Plan For Someone With A Low Risk Tolerance?

  • A client of mine was recently widowed and needed a portfolio where she doesn’t have to worry. She lives conservatively so she has a conservative portfolio because she can thrive with conservative returns. In this case, we have 35% of her portfolio in safety–bank and annuity-type products. Then there is a 10% section totally at risk. Finally 55% of her money is in between stock and bond investments depending on if we are in a long-term downtrend or uptrend.

[11:28] – What’s It Look Like To Have A Conversation On Risk Tolerance With Your Advisor?

  • We have a complete planning review that looks at a portfolio. We do a risk evaluation and understand a person’s risk tolerance, and then show how much risk they have actually have.

Today’s Takeaway:


More From David:

The host: David Dickens

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