A well-constructed investment portfolio should be in direct alignment with your risk tolerance. In general, a more conservative portfolio should go up less when the markets are hot, but it will have less volatility over time that equates to a smoother ride. On the other hand, a more aggressive portfolio will have more volatility and a bumpier ride but it might reap greater returns when the markets are hot.
How much market volatility can you stomach?
You need to understand your own ability to stomach and withstand bad market conditions.
This is easier said than done for most investors. In casual conversation, you may feel confident about being able to keep your cool and hold it together when the markets are crashing. However, your confidence might betray you when looking at the red ink all over your portfolio as it drops in value.
This is why it is important that your portfolio is allocated in a manner that matches the amount of market volatility that you can stomach.
Know your ability to generate income
Generally, you can take on more risk if you have a high paying job or multiple streams of reliable income. Being in a position to generate income from other sources means that you are not solely relying on your investments to survive. In this case, you will have the ability to be exposed to more risk to possibly generate greater returns.
On the hand, your ability to generate income may be very low if you are retired or nearing retirement. In this case, you may want to minimize your exposure to the markets and construct your portfolio in a more conservative fashion. Especially if you are currently receiving distributions from your investment portfolio for retirement income.
The bottom line is this...
When determining your risk tolerance you need to have these two factors at the forefront.
Understand how much volatility you can stomach.
Factor in your ability to generate income.
These two factors will put you on track to accurately assess your risk tolerance.
This is a major problem with employer-sponsored 401(k) plans. In many cases, employers do not take the time to identify each employee's individual risk tolerance. Instead, they use a one-size-fits-all approach.
The problem with this method is that everyone's financial situation and goals are different. Your investments should be uniquely constructed to fit your specific risk tolerance as it pertains specifically to you.
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Disclaimer: Hudson Wealth Management, LLC (HWM) is a FINRA registered investment adviser firm. Investing in securities involves risks, and there is always the potential of losing money when you invest in securities. Before investing, consider your investment objectives and HWM's fee schedule. The information provided herein is for illustrative purposes only and does not constitute personalized investment advice, recommendations or solicitations to hold, buy or sell any investment or security of any kind. All images and return figures shown are for illustrative purposes only and are not actual customer or model returns. Past performance does not guarantee future results.
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