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The Investor Risk Profile: Understanding Risk

Posted by Michael Kane on Sep 9, 2016 1:40:49 PM
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investor-riskEconomist Paul Samuelson, the first American to win the Nobel Memorial Prize in Economic Sciences, famously said, “Investing should be like watching paint dry or grass grow. If you want excitement, take $800 and go to Las Vegas.” Years later, Samuelson’s sentiment still rings true.  

Unfortunately, this outlook will never apply to an investor whose investments are not aligned with his or her individual tolerance for risk.

INVESTOR BEHAVIOR

Dalbar, one of the nation's leading financial services market research firms, publishes its influential Quantitative Analysis of Investor Behavior each year. Year after year, the study shows how poorly typical investors perform versus the general market. The most recent study showed that over a 30-year period, equity fund investors earned just 3.8% per year (barely 1% over inflation), while the S&P 500 produced average annual returns in excess of 11%. 

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Source: Dalbar 2015 Quantitative Analysis of Investor Behavior


Are investors simply picking bad funds? Not necessarily. According to Dalbar’s study, investors tend to make poor decisions about risk and market timing because of emotions. These include:

  • Expecting high returns and low risk
  • Taking undue risk in one area and avoiding rational risk in another
  • Tendency to overreact to day-to-day market news and developments
  • Making decisions without considering all implications

RISK TOLERANCE AND INVESTMENT DECISIONS

For many pilots nearing retirement, investing in the financial markets can feel like gambling with your future. Not only that, but the very nature of market volatility can wreak havoc on the psyche of investors, causing them to make irrational short-term decisions or deviate from carefully-laid long-term plans.

“Investing should be like watching paint dry or grass grow.
If you want excitement, take $800 and go to Las Vegas.”

Most investors are unaware of their own risk tolerance until there are critical economic events or significant movements in the market. Unfortunately, by then, it’s too late to correct.

For example, those nearing retirement in the fall of 2008 suffered devastating losses in the financial markets due to a “perfect storm” of unprecedented consumer debt, the subprime mortgage crisis, and huge losses accrued by firms like the now-defunct AIG and Bear Stearns. But those who exited the market in a panic missed out on the eventual recovery.

YOUR RISK PROFILE

A skilled investment advisor will work with you to create an investor risk profile that takes into account your current situation, special conditions that may affect your retirement, and your personal financial goals. This customized risk analysis becomes a key driver (but not the only one) for the selection of an investment strategy that you and your advisor will pursue to help you achieve your retirement savings goals.

The results of each risk assessment are as individual as the person it represents. For example, not all people nearing retirement are risk-averse, and not all people who are further from retirement are comfortable taking bigger risks. The key is this: be aware of your personal comfort level concerning investment risk as you plan for the future.

To find out what level of risk is appropriate for you, take a 25-question assessment to get your personalized risk score. 

Take the Questionnaire

 

 

Disclaimer: This blog is intended for informational purposes only and should not be construed as individual investment advice. Actual recommendations are provided by Retirement Advisors of America following consultation and are custom-tailored to each investor’s unique needs and circumstances. The information contained herein is from sources believed to be accurate and reliable. However, Retirement Advisors of America accepts no legal responsibility for any errors or omissions. Investments in stocks, bonds, and mutual funds may increase or decrease in value. Past performance is no guarantee of future results. Any of the charts and graphs included in this blog are not recommendations for the purchase and sale of any security. 

Topics: Financial Planning