I was discussing retirement investing with a coaching client and he mentioned that he had a high risk tolerance. He’s married, 45 years old, has 2 kids, and currently allocates 95% of his retirement portfolio to equities (using index funds). When I asked about why he’s so aggressive, he candidly told me he’s a risk taker. He had gone sky diving, climbed major mountains, and even tried bull riding. He believed in living life to the fullest.
As our conversation continued, it occurred to me that my client was projecting his personal risk tolerance onto his investing behavior. In life, he’s a risk taker. In investing, his willingness to take risks is only part of calculating his risk tolerance. A few other considerations in determining how much risk he should take include:
- Does he work in a job that has high employment? At 45, his financial future is still highly contingent on having a job. If he’s in an industry with massive layoffs, he should lower the risk in his portfolio.
- Does he have an inheritance? If there is money coming in after his parents pass, he can take more risk. If not, he’s on his own.
- Does he have a pension? Pensions are near extinct but, if he has one, it’s additional monthly income that may last for life, and he can take more risk with his portfolio.
- What is his family medical history and life expectancy? If most people in his family live past 90, chances are, he should plan for the same.
- What’s his investing behavior? People say they are risk tolerant until the market crashes. If he’s liable to pull out when the market dips, he should consider a more conservative portfolio. What did he do during 2008 and early 2020?
Remember, the key to retirement is to never outlive your money. With that in mind, your risk tolerance should be based on a complete understanding of future sources of income, potential challenges, and investing behavior. While jumping out of plane can be an amazing thrill, it’s only part of the equation when it comes to your financial life.
What other considerations should you have when assessing your risk tolerance? What is your risk tolerance and why?