There are typically three risk profiles that investors are assigned to within the financial services industry, which is conservative, moderate, and aggressive. These categories are usually defined by an investor’s;
These components help to make up what is called your investment risk profile. However, your risk profile may be very different from your risk perception while your risk profile may remain quite constant for years or even decades, your perception of risk changes with time, experience, and circumstances.
Understanding yourself is the most crucial part of not only the investment process but in life as well when you consider putting together your wealth management plan. Your reactions, your personality traits, your biases, your limitations all play a critical role in the investment and planning processes.
Let’s look at the following example;
This example illustrates why real risk management is about creating behaviorally aware portfolios, not fancy mathematical risk measurement techniques. The most significant risk for investors is never a black swan or even a market-moving geopolitical event. The most significant risk for investors is themselves.
Much of risk is subjective, hidden, and unquantifiable. However, at its most basic level, investment risk is the likelihood of losing money. We have touched on the first step regarding risk, which is understanding it, your risk profile vs. risk perception. The second step is recognizing when it is high. The critical final step is controlling it.
One of the most important things you can know about investment risk is surrounding probability and outcome. “Probable things fail to happen, and improbable things happen all the time.” Risk control is invisible in good times, especially when stock markets are skyrocketing higher and are likely to generate subpar returns.
However, good times can so quickly turn into dangerous times at which point risk control is the best route to loss avoidance. Risk avoidance, on the other hand, is likely to lead to return avoidance as well.
In his article What Are You Afraid Of?, Dr. Steven Novella, an academic clinical neurologist at Yale University School of Medicine, raises the question as to why do so many people worry about the (statistically) wrong things. Below are a few of his conclusions;
While emotions can work to our benefit, they can indeed work to our detriment, especially when it comes to handling our financial lives. At times we may become so consumed with our fears and emotions that we do not know how to hit the stop button to reset and begin anew with a different perspective.
Here are some helpful aspects to keep in mind when considering and understanding your risk perception;
You build your portfolio for the time frame that is best suited to accomplish your financial and lifestyle goals. Becoming too focused on the day-to-day movement of your portfolio balance will only undermine the hard work you have already done.
There is More Than Investment Risk When It Comes to Wealth Planning
When it comes to wealth planning, there are other risks to consider besides investment or portfolio risk. An often overlooked financial and life asset is your career. One of the best things that you can do for your investment portfolio is to continue to focus on your career investment.
Investing in yourself and making sound financial decisions can reduce your wealth planning risk. This is where wealth management risk becomes more important than asset management risk. The equation for building wealth is no secret, but it does require a hefty dose of discipline rather than IQ;
While all of these are critical, probably the most vital and overlooked aspect of investing is investing in one’s self. By investing in yourself and changing your focus, you can change your financial life. Maximizing your primary source of income by making yourself valuable to other people in some way is one way to generate increased wealth in addition to saving and making sound financial decisions.
There’s no perfect formula for your willingness, ability, and need to take the risk. In trying to define your risk tolerance, your principal objective is to balance out your future goals with your desire to sleep soundly at night. Again, this applies to not only your portfolio but the other decisions that you make in life, which will have an impact on your wealth management plan in total.
For questions about any wealth planning and asset management topics, do not hesitate to contact me to find out what options may be best for your situation.