How Much Investment Risk is Right for You?

November 19, 2024

Figuring out how much risk to take with your investments isn’t straightforward. It depends on your financial goals, how long you plan to stay invested, and how comfortable you are with investment market volatility. Retirees and high-net-worth individuals often face the challenge of wanting to grow their savings while protecting what they’ve worked so hard to achieve.

Understanding your risk tolerance is a big part of this process. It helps you decide how much uncertainty you can handle without losing sight of your goals. Too much risk could put your investments under pressure, while playing it too safe might mean missing out on opportunities to grow your wealth.

This article will break down what investment risk means, how to figure out your personal comfort level, and practical ways to manage it. By the end, you’ll have a clearer picture of how to balance growth and security to build a strategy that works for you.

Overview of what investment risk is

Investment risk is simply the chance that your investments might lose value. Some types of investments, like stocks, offer the potential for higher returns but come with greater uncertainty—they can rise quickly, but they can also drop just as fast. Others, like bonds or real estate, are generally more stable, though their growth tends to be slower and steadier.

For retirees and high-net-worth individuals, understanding these differences is essential. At this point, you might be focused on protecting your wealth while also aiming for some degree of growth. To make informed decisions, it’s important to think about how much risk feels manageable for you.

This is where the concept of risk tolerance becomes essential. Are you okay with seeing your portfolio’s value rise and fall due to market swings, or does that level of unpredictability feel overwhelming? Your comfort with these changes will have a big impact on how you decide to allocate your assets. Without knowing your risk tolerance, you might end up taking on too much risk, creating unnecessary worry, or avoiding risk entirely, which could limit your portfolio’s potential.

By understanding your boundaries, you can make smarter decisions about your investments and better align them with your financial goals.

Types of Risk Tolerance

Your willingness to take on risk is personal and depends on how comfortable you are with uncertainty in your investments. Some people prefer slow and steady growth, while others are fine riding out big market shifts for higher returns. Recognizing your risk tolerance guides your decisions and helps ensure your strategy matches both your financial goals and emotional comfort.

Let’s explore the three main types of risk tolerance: conservative, moderate, and aggressive.

  • Conservative Risk Tolerance
    If you’re someone who prioritizes safety, conservative risk tolerance might be a good approach for you. This approach focuses on preserving your wealth, often favoring investments like bonds or fixed-income options that don’t experience sudden value changes. For retirees, this approach can provide a sense of security, as these investments generate steady income without exposing savings to large losses. Small allocations to stocks may still be included for gradual growth, but the emphasis remains on keeping your portfolio stable and predictable.
  • Moderate Risk Tolerance
    A moderate investor balances growth and stability. This approach typically involves spreading investments between stocks and bonds to achieve steady returns without exposing the portfolio to excessive risk. Stocks offer the potential for long-term growth, while bonds act as a safety net during market downturns. This balance works well if you’re comfortable with some ups and downs but still prefer a degree of security. It’s a practical choice for those who don’t need immediate access to their funds and are willing to wait for gradual gains over time.
  • Aggressive Risk Tolerance
    Aggressive investors are more focused on building wealth and are comfortable with significant market swings. Their portfolios often feature a large percentage of stocks, aiming for higher returns over time. While the potential for loss in the short term is greater, the long-term rewards can outweigh those risks. This approach requires patience and confidence in the market’s ability to recover. If you can handle periods of volatility and stay committed to your strategy, aggressive investing might align with your goals for substantial growth.

Determining the right investment risks for you

Determining the right level of risk starts with knowing your financial goals. Are you focused on steady income, building long-term wealth, or striking a balance between the two? These priorities shape how much risk you should take and where you should allocate your money.

  • Assess Your Financial Goals
    Think about what you need your investments to achieve. For retirees, the focus often shifts to preserving wealth and creating a reliable income stream. Meanwhile, those still building their portfolios may aim for growth, even if it means taking on more risk. Identifying your priorities is the first step in deciding how much uncertainty you’re willing to handle.

    Take this example: Imagine someone who has recently retired and no longer has a regular paycheck. Their main concern is ensuring their savings can generate enough income to cover living expenses for the rest of their life. To achieve this, they might lean toward lower-risk investments, such as bonds or dividend-paying stocks, that provide predictable returns while safeguarding their principal.

    Now, consider someone who has accumulated significant wealth but is still in their earning years and looking to grow their portfolio further. This person might choose to invest heavily in stocks or real estate, knowing that these options come with higher risk but also the potential for greater long-term rewards. Their strategy could involve balancing these higher-risk assets with safer options to maintain some level of stability.

    By understanding your financial goals, you can gauge the level of risk that aligns with what you’re trying to achieve, helping to ensure your investments support both your short- and long-term needs.
  • Review Past Investment Experiences
    Looking back at how you’ve handled investment decisions during uncertain times can reveal a lot about your risk tolerance. Did market ups and downs leave you feeling anxious, or were you able to stay calm and stick to your plan? Your previous reactions can serve as a guide to help you make smarter choices in the future.

    Imagine an investor during a significant market downturn. Their portfolio lost 20% of its value in just a few months. One person might have decided to sell their investments immediately, fearing further losses. This decision reflects a more cautious approach and suggests a preference for lower-risk investments in the future.

    Now think of another investor in the same situation who chose to hold onto their investments despite the drop. Over time, the market recovered, and their portfolio rebounded. This ability to endure market volatility indicates a higher tolerance for risk and a long-term mindset.

    By examining your past reactions, you can better understand what type of investor you are and use that knowledge to shape a strategy that aligns with your comfort level and financial goals.
  • Measure Your Emotional Tolerance
    Understanding how much market volatility you can handle emotionally is just as important as assessing your financial goals. If seeing your portfolio drop in value causes stress or sleepless nights, safer investments might be a better fit. On the other hand, if you can stay calm and stick to your plan during downturns, you might be able to take on more risk for potentially greater rewards.

    An investor notices their portfolio has dropped by 10% after a market correction. They immediately feel uneasy and start questioning whether they should sell their investments to avoid further losses. This anxiety suggests a lower tolerance for risk, indicating that their portfolio might need to lean more toward bonds or other stable investments that don’t experience large swings in value.

    Now picture another investor in the same situation. Instead of panicking, they review their long-term goals and remind themselves that markets historically recover over time. Confident in their plan, they choose to stay invested, even adding more to their portfolio while prices are low. This calm and calculated response suggests a higher emotional tolerance for risk, making them more suited to a strategy that includes a greater allocation to stocks or other growth-oriented assets.

    By measuring how you react to market changes, you can align your investment choices with a strategy that fits both your financial goals and emotional comfort.
  • Do not Forget to Rebalance Regularly
    Even after identifying your risk tolerance, your portfolio isn’t a “set it and forget it” situation. Life changes, financial milestones, or shifts in the market can alter your needs and risk tolerance. Regular rebalancing helps to ensure your investments remain in line with your goals and current circumstances.

    Imagine this scenario: An investor initially builds a portfolio with a 60% allocation to stocks and 40% to bonds. Over the years, strong stock market performance causes the portfolio’s balance to shift to 75% stocks and 25% bonds. While this might seem like good news, it also means the portfolio has become riskier than originally intended.

    Now, let’s say the investor is approaching retirement. They decide to rebalance by selling some stocks and reallocating funds to bonds, restoring the original 60/40 split. This adjustment reduces risk and creates a more stable portfolio, better suited to generating steady income during retirement.

    Rebalancing isn’t just about maintaining ratios—it’s about keeping your portfolio aligned with where you are in life and what you need your investments to accomplish. By reviewing and adjusting regularly, you can help manage risk while staying on track to meet your financial goals.

Wrapping up

Ultimately, the right level of investment risk depends on your individual comfort and financial goals. For retirees and high-net-worth individuals, understanding your risk tolerance is essential to creating a strategy that strikes the right balance between protecting what you have and growing it for the future.

Keep in mind that your financial needs and comfort with risk may shift over time. Regularly reassessing your tolerance and adjusting your portfolio helps ensure your investments stay aligned with your evolving goals. By staying proactive and mindful of your risk preferences, you can navigate changes in life and the market while keeping your financial plan on track.

Landsberg Bennett is a group comprised of investment professionals registered with Hightower Advisors, LLC, an SEC registered investment adviser. Some investment professionals may also be registered with Hightower Securities, LLC (member FINRA and SIPC). Advisory services are offered through Hightower Advisors, LLC. Securities are offered through Hightower Securities, LLC.

This is not an offer to buy or sell securities, nor should anything contained herein be construed as a recommendation or advice of any kind. Consult with an appropriately credentialed professional before making any financial, investment, tax or legal decision. No investment process is free of risk, and there is no guarantee that any investment process or investment opportunities will be profitable or suitable for all investors. Past performance is neither indicative nor a guarantee of future results. You cannot invest directly in an index.

These materials were created for informational purposes only; the opinions and positions stated are those of the author(s) and are not necessarily the official opinion or position of Hightower Advisors, LLC or its affiliates (“Hightower”). Any examples used are for illustrative purposes only and based on generic assumptions. All data or other information referenced is from sources believed to be reliable but not independently verified. Information provided is as of the date referenced and is subject to change without notice. Hightower assumes no liability for any action made or taken in reliance on or relating in any way to this information. Hightower makes no representations or warranties, express or implied, as to the accuracy or completeness of the information, for statements or errors or omissions, or results obtained from the use of this information. References to any person, organization, or the inclusion of external hyperlinks does not constitute endorsement (or guarantee of accuracy or safety) by Hightower of any such person, organization or linked website or the information, products or services contained therein.

Click here for definitions of and disclosures specific to commonly used terms.