Have you heard that you should be in 40% bonds and 60% stocks because you are 40? Or wait is it 50% bonds and 50% stocks when you are 40? Or should you diversify and also own gold because “you never know”? What if I told you all of these general rules don’t mean anything. Generic advice in finance rarely applies to you. You need to know how much investment risk you can handle. If your portfolio is 60% stocks and 40% bonds and you are going to have book an emergency appointment with your therapist if the market goes down 20%, then you are exposed to way too much investment risk.
How much is too much?
How much are you comfortable seeing your portfolio go down while still sleeping at night? The right measure of investment risk let’s you sleep at night and let’s your money grow at a rate that will help you achieve your goals. No one likes to lose money, but you shouldn’t be crushed with worry when the market takes a dip.
No investment is risk free. Whenever your money is in anything other than cash there is some risk that you will lose money on that investment. Some investments, like bonds from the US Treasury, carry very low risk. It is unlikely the US government will not pay its debts which makes the investment risk very low. Since the investment risk is low so is the potential return.
On the other hand stocks carry more investment risk. This varies by the size and history of the company – for instance Apple is a less risky investment than a new tech company that just went public. The return on stocks is higher because you must be compensated for taking on more risk.
Ignore the rules of thumb and get your number
There are tons of rules of thumb out there telling you how risky you “should” be based on your age. In theory they are correct. If you are 30 and your portfolio is 80% in stocks and your portfolio goes down by 30% you will have time to wait for those stocks to go back up. But what happens if you have little risk tolerance despite being 30. What if seeing your portfolio go down 30% leaves you heaped in a pile, weeping on the bathroom floor?
It is important to figure out how much investment risk YOU can handle, not how much risk other 30 year olds can handle. I use a tool from Riskalyze to analyze how much risk my clients are comfortable taking. Then I help them build a portfolio that is appropriate for their risk level and their long-term goals. You can take the risk quiz below and you will receive a personalized risk number. This number will help you build a portfolio that is appropriate for you…and hopefully keep you off the bathroom floor.
I’m guessing you have a friend who might end up in that emergency therapy appointment if the market takes a dip. Share this so she can take the quiz too.