How aggressive should your investments be?
When designing your personal investment strategy, one of the most important questions you need to answer is, “How aggressive should my portfolio be?” The answer is usually given in terms of asset allocation and expressed as a percentage — such as 60% stocks / 40% bonds. This is referring to how your portfolio is divided among different investment types.
Stock investments (you own shares in companies) are usually considered riskier, while bond investments (you lend to companies or governments) are considered less risky. As the saying goes, “no risk, no reward” — allocations heavy on stocks could bring great gains or great losses. Allocations heavy on bonds, on the other hand, may not deliver high returns, but you’re less likely to lose on your investment.
But how does an investor (or their advisor) decide how aggressive to be?
There are some interesting questions that purportedly get you close to an answer: Do you prefer the slow lane or the fast lane? Like trying new restaurants or prefer the old favorites? These aren’t helpful at all.
There are other formulas, like the classic “100 Minus Your Age.” Using this guide, a 60 year old subtracts their age from 100 to find how much of their portfolio should be in the riskier stock investments, arriving at 40%. This is way too simplistic. It lumps everyone into a single bucket, and takes no account for complexities of retirement planning — such as higher life expectancies or today’s incredibly low interest rates (factors that impact investing success).
How about a “risk assessment quiz”? This is a typical start for most investors, and it includes questions like, “How would you react if your portfolio plunged more than 30%?” These quizzes can certainly be insightful, but they are mainly measuring your personal reactions. They do little to factor in your personal external situation. As a recent Wall Street Journal report pointed out, your answers are really just measuring your likelihood to experience regret, fear or overconfidence when investing.
So, how do you determine how aggressive to be when investing? Here are the seven questions we ask as we design personal investment strategies:
1. What’s the purpose for this money?
Assigning a purpose is foundational to your strategy. Common investment purposes include retirement income, future purchases (like a home down payment or a business), or a child’s college tuition. Simple wealth building is a possible objective too, but the more specific your investment intention, the more meaningful your investment strategy.
2. When will you most likely need it?
Where your objective falls on the time horizon is one of the biggest determinants to how aggressive or conservative you should be. If the established purpose is short term — for example, you’re planning a home purchase in the next few years — then your strategy needs to avoid the possible market spikes and dips that come from aggressive investing. The longer the timeline, the more your strategy can accommodate volatility.
One common mistake: new retirees often assume they have a short time-frame, but the reality is usually more complicated. In addition to preparing for the start of retirement, most also need to consider withdrawals all the way through the end of retirement — possibly 30+ years away!
3. What’s your investing experience?
Are you just dipping your toe into the world of investing, or are you a seasoned pro? Like anything new in life, it’s wise to start new ventures with some caution. Those who lack experience can counter-balance their ignorance with informative books and qualified investment professionals.
4. How comfortable are you with volatility?
This is where those “risk tolerance” quizzes can come in handy. They can help you gauge your comfort level with historical swings in the market. But remember, quizzes are theoretical. It’s one thing to say you can stomach losses. It’s another to keep your resolve when the news media is reporting the end of the world.
5. What return do you need to achieve your objectives?
Do you even need to take the risks? Think back to the purpose of your money. If you can meet your objectives with a more conservative approach, why risk it?
6. What investment selections are available?
You may be limited by holdings inside a 401k, or you may not have access to private ventures that may offer higher levels of risk/reward than available in public markets. The selections available to you are key in determining your plan.
7. What investing “scripts” are you bringing with you?
Recognize that you may have a particular set of beliefs or “scripts” that influence your decisions. We all have a series of money scripts — beliefs about money that guide how we treat our finances. These scripts may be based on what’s worked in the past or what others have passed on to you. Some investing scripts: markets are a gamble, never own stocks, never own bonds, utilities are safer, one in the hand is worth two in the bush, etc. Uncovering your own scripts can help you see the pitfalls you’re prone to or the false assumptions you could be making.
Determining your investment strategy is as much an art as a science, because the only way to know for sure whether you got it right is to see into the future. So, review it regularly with your financial planner to make sure it is up to date with what is going on in your personal life or the current economic realities.
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