Investing for your future can be both nerve-wracking and exciting, especially for new investors. While there are wealth managers and financial advisors that can assist you in putting together an award-winning portfolio, your risk tolerance and hope for reward (returns on your investments) are important to understand before you dive in head first.
The most important aspect to remember when determining your risk tolerance (and in return, your reward) is the time frame in which you need the money available. Since a great deal of investment is tied to retirement, we will use that as our example. Keep in mind that the higher the risk, the higher the reward and potential for loss. So, a person’s risk tolerance generally decreases as they come closer to retirement.
Early in your career (let’s say your 20s, 30s, and into your 40s), you have a long working life ahead of you. You will be saving up for retirement over the next 40 years, and would like your principle to grow at a relatively quick rate. Also, if there happens to be a significant downturn in the investment markets, you have plenty of time to recover.
During this phase of saving for retirement, you will often look to real estate, individual stocks (both foreign and domestic), and mutual funds that have a higher mix of stocks. Usually, you will have a low percentage of bonds and CDs during this time.
Late Stage of Your Career
As you move along in your career (let’s say you’re in your late 40’s until you consider retirement), the assets in your portfolio should become more conservative. At this point, you and your wealth manager should consider a lower mix of stocks (and these stocks should be domestic as foreign stocks tend to be riskier) and a higher risk of investment grade bonds from well-known companies.
These bonds often have a fixed rate of interest that is paid to the investor, and can be cashed in for face value when the bond matures. As you grow older, you would still like to earn some return on your investments, however, you no longer have 40+ years to recover any principle loss during a downturn.
Retirement and Beyond
During retirement, your goal is generally to have your assets locked up in very safe, and liquid assets. At this point in time, you should generally steer clear of most individual stocks, and focus on assets that will preserve your capital (think CDs and the highest rated municipal, treasury, and corporate bonds that will be held to maturity).
Your retirement assets will be used to sustain your lifestyle, hopefully as long as you need them. At this point, you have no time to earn back any losses due to the stock market.
Keep in mind that your risk/reward tolerance often changes as you move along towards retirement. This is generally due to the fact that you have less time to recover if there is a significant down turn in the markets – consider how many people lost their life savings close to retirement during the Great Recession.