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How often should I re-evaluate my risk level in my portfolio?

Is my portfolio's risk level related directly to my own comfort level regarding risk, or are there certain benchmarks in my life where I should be lowering the amount of "risk" in my assets no matter what? I have medium to high level risk investments currently and while I'm comfortable with it, my friends have told me that at my age (52) I should be more conservative with my investments. Any thoughts?

Jul 17, 2012 by Rodney from Bloomington, IN in  |  Flag
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George Cones, JD Level 20

Let us begin by saying it would be a good idea to visit a fee only investment advisor, let us tell you we might approach your situation.

Unless you have some extraordinary cash flow needs, like having to care for a ill spouse, child or parent, we believe the most important driver of risk should be years to retirement. A broadly diversified portfolio, with a gradually declining 50%-70% weighting in stocks, is good for up to 10 or so years prior to retirement.

The following is a basic approach that may work for you as you approach retirement. Remember one of the best means of reducing risk is investing in a broad range of asset classes in diversified portfolios.

  1. You should have 3-5 years of cash flow needs in CD's, money market funds and short-term bonds, which will provide protection in the event of interest rates rises, with some extra pad for extraordinary expenses. This portion of the portfolio should provide 3-5% returns over the long-term (emphasis on long-term). This cash flow on which you live could come from social security, pension benefits, taxable assets, and your 401(k) plan.

  2. You could invest the remainder of your portfolio in a very diversifed stock/bond portfolio. The portion of the portfolio should be diversified across all areas of the stock and bond markets. A good approach is investing in Index ETFs, index mutual funds, and/or low-cost, diversified, actively managed mutual funds.

  3. Another way to increases cash flow is to be sure that capital gains and other income is paid to you in cash, not reinvested in the mutual funds. You can either use the cash to meet you expenses or reinvest the cash in the areas of the market where you see bargains.

The short-term portion of your portfolio should provide a less risky base or foundation. If you have 3-5 years of cash flow available, you should have time to ride out market ups and downs in your stock/bond portfolio, while increasing your long-term returns.

1 Comment   |  Flag   |  Jul 17, 2012 from Wilmington, DE
George Cones, JD

I should add based on David's response, investors should understand that they need to develop a long-term strategy and stick to it. One of the most common mistakes of individual investors make is to change their allocation at the worst possible time. This is borne out in study after study. Institutional investor tend to ourperform individuals because they have long-term strategic allocations.

Flag |  Jul 17, 2012 near Wilmington, DE

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Your portfolio's risk level is absolutely the most important consideration you have in investing! The degree of risk you take should be a function of both Risk Capacity and Risk Tolerance, two very different assessments. In assessing your Risk Capacity, you should consider quantitative, objective factors including your current and future income, your current and future spending needs in relation to your present wealth, realistic expected returns from various asset classes, and the importance of achieving your financial objectives, i.e. how much risk can you AFFORD to take? Risk Tolerance, on the other hand, represents emotional and behavioral factors which will determine how you will respond to the inevitable ups and downs of risky asset classes, i.e. how much risk do you WANT to take?

Instead of relying on age-based rules of thumb or portfolio risk levels designed for your friends, who may be in very different financial circumstances, we recommend that you carefully consider your own personal Risk Capacity and Risk Tolerance. Then design a portfolio that reflects this. If Capacity exceeds Tolerance, go with Tolerance - it's much more important to sleep comfortably and you'll probably live longer with less worry over your investments!

As always, a qualified financial planner can help you in assessing your risk capacity and risk tolerance.

Good luck!

Comment   |  Flag   |  Jul 17, 2012 from Morristown, NJ

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Excellent question Rodney, I concur with George and David a qualified financial professional would be best at helping you answer this question tailored to your personal situation. You should be familiar with how you are compensating the professional you employ, whether it is flat fee based (the longer the person works the more they make), a management fee (you make more, they make more money and you lose money, they make less), or the person is employed by a large corporation to sell their products (broker/sales person/commission).

What are your investment goals? What is the current size of your investments? What is your capacity to add to your investments? What is your psychological capacity to deal with price fluctuations of your investments? What is the rate of return you need to achieve to reach your investment goals? What is the projected future rate of return of your investments? What’s more important to you, loss of principal or loss of purchasing power? These are some of the questions that a professional should help you answer.

No one I know knows the future. If they do know the future, they’re not publishing it on the internet.

I do believe in planning and utilizing the lessons of history. When the situation in the present changes, it is necessary to change your plan so you will survive, adapt, and overcome.

An 80 year old with $10,000 in their checking account as their only liquid asset should not have the same asset allocation as Warren Buffet. I don’t believe Warren Buffet has 70% or more invested in fixed income. Asset allocation based on age alone may be inappropriate in today’s rate environment.

You need to have the risk level that is customized to Rodney from Bloomington, IN so you will have confidence in your portfolio when others are running for the doors.

There is one axiom that has held true in my 25 years of experience “no risk, no return”.

An investor needs to understand as many risks as possible. They need to mitigate as many of the known risks as is economically prudent. They need to accept there will always be some portion of risk that is unknown. They need to accept, less risk equals less reward and too much risk equals failure. Risk needs to be balanced with capacity and tolerance.

Good luck Rodney, great question, sorry there isn’t a simple answer.

Comment   |  Flag   |  Jul 17, 2012 from Thousand Oaks, CA

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Ryan Level 19

Rodney, you are getting good solid advice from the professionals answering your question and I agree with what I am reading fully. You are smart to recognize that you are likely entering a strong accumulation phase for retirement that needs to be invested appropriated for your risk tolerance and time horizon. Many have learned that the events of 2008 when the US market dropped heavily caused a number of those within 5 to 10 years of retirement to extend their working careers, often because they sold investments at the wrong time, had the wrong allocation to begin with, or decided to stop putting money into retirement savings. All of these are potentially what I call generational game changers in terms of your own retirement planning and lifestyle and how it relates to your ability to spend time with family and friends and perhaps provide something for beneficiaries.

Comment   |  Flag   |  Jul 18, 2012 from Gettysburg, PA

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