Investing is a crucial part of achieving long-term financial stability, but with so many different options and strategies, it can be difficult to know where to start. One starting point to investing is understanding your own risk tolerance, or the amount of risk you are comfortable taking on in order to achieve your financial goals. Each person will have their own levels of risk that they’re comfortable taking in their financial journey. While knowing your risk tolerance is a helpful tool, there are unfortunately many myths surrounding it that can lead people astray.
In this blog post, we will uncover four of these myths to provide a clearer understanding of what risk tolerance truly means. By understanding the truth behind these misconceptions, you can make more informed decisions about your investments and work toward your financial goals with greater confidence.
Myth 1: Time Horizon Determines Your Risk Tolerance
One myth I hear frequently is that the time horizon you have for your investments should determine your risk tolerance. While this thinking is quite popular, I actually don’t agree with it. For instance, if you have a long time horizon but a low tolerance for risk and a limited amount of funds to invest, you may not be comfortable taking on significant risk even if you have a long time horizon.
On the other hand, if you have a shorter time horizon and a high risk tolerance, you may be comfortable taking on more risk to potentially realize higher returns in a shorter amount of time.
Your time horizon should be a factor to consider in determining your risk tolerance, but it needs to be considered along with your overall financial situation and goals. Simply assuming that if you have a longer time horizon means you will have a higher risk tolerance isn’t quite accurate, and more work must be done to get the right amount of risk.
Myth 2: Your Risk Tolerance Stays the Same Over Time
People are not born with a certain risk tolerance that stays the same over a lifetime. Just like your hobbies, interest, career and relationships will change, your risk tolerance may change as well.
In fact, it’s not unusual for new investors to have lower levels of risk tolerance when they start investing, but as they learn more and go through some good (and bad) market periods, they actually develop a higher risk tolerance than when they started. Those same investors may go through more changes with their risk tolerance as they approach retirement.
Your risk tolerance for investments will always be changing, just like you are always changing. It’s important to select the right amount of investment risk when you start, but also to reevaluate it over time.
Myth 3: High Risk Equals High Return
There is a common belief, repeated quite often, that the higher the risk, the higher the potential reward. However, this is not always the case, as taking on high risks can lead to significant losses as well. Things like cryptocurrency, day trading, and penny stocks are all very high risk, but are very unlikely to lead to high returns.
Don’t fall for the myth that just because something is high risk means that there is a high return associated with it; these types of “risks” can actually derail your financial plan and set you further back from reaching your goals.
Myth 4: Risk Tolerance Solely Determines How You Invest
Yes, your risk tolerance is very important. But it shouldn’t be the sole determining factor in creating your investment strategy. Your current financial situation, your family situation, and your future financial goals are all factors that need to be considered, along with your risk tolerance, to come up with the best investment strategy.
For instance, you might have more than enough money in your investment accounts and Social Security benefits to have a secure and comfortable retirement. In that situation, you may be able to select investments with lower risk levels to meet your income goals. On the other hand, if you are 10 years from retirement and have some catching up to do, you may need to consider choosing investments with higher levels of risk so you can earn the returns you need in order to retire on time.
Choose Investments Aligned With All Aspects of Your Life
If you’ve been struggling to come up with the right investment strategy that factors in your level of risk tolerance, we’d love to help. We at Horizon Planning Group have created a free questionnaire that will help set you on the right path. Take the Risk Tolerance and Investment Objectives Questionnaire here.
Once you’ve done that, if you need more help aligning those investments with your financial goals, feel free to schedule an introductory meeting online or reach out to me at (770) 627-4157 or Nick@MyHorizonPG.com to get started.
Nick Marrano is financial advisor at Horizon Planning Group, a full-service fiduciary financial planning firm committed to always doing what’s right for their clients. With almost 10 years of experience, Nick spends his days serving his military and first responder clients who give their lives to serve others. As a former U.S. Marine, he understands their challenges and desires to help his clients navigate their military benefits and customize a plan to their lifestyle that allows them to pursue their goals with confidence.
Nick has a bachelor’s degree in finances from Kennesaw State University. He lives in Marietta, Georgia, with his wife, daughter, and their two dogs. His favorite things to do are being outdoors with his family, traveling, and completing projects around the house, but he also won’t say no to unwinding with his friends and playing Xbox. Nick cares deeply about his community and gives back by volunteering with the Make-A-Wish Foundation and local charities that support foster-care needs. To learn more about Nick, connect with him on LinkedIn.
This is for educational and informational purposes only and is not research or a recommendation regarding any security or investment strategy.
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