These 2 Factors Matter More Than You Think With Your Investments
Investing money is one of the more exciting things to do with it. Sure, you can spend it and buy nice things, but have you ever invested money and received a killer rate of return? It’s one topic that people who have exposure to investments love to talk about. This stock they own did X; their 401k portfolio did Y; they know a guy who took fifty cents and turned it into a million! It’s exciting because it affords you the ability to take money that you saved at an earlier time in life and turn it into something potentially more for the future. This can be a major purchase, college, retirement, etc. There is a lot to consider when you take your money and expose it to the world of investing. The two factors that we will discuss will guide how you invest your money from when you just start out all the way to when you are ready to retire.
The two concepts that I am bringing up are your time horizon and your risk tolerance. From an advisor’s perspective, without these two categories, it is almost impossible to give you true guidance on how your money should be allocated. Simply put, your time horizon is “when do you need the money” and your risk tolerance is “how much money are you willing to risk in order to achieve certain returns.” Both items help determine how “aggressive” one should be when they are exposing their money to the stock and bond market. If you need any of the money within a 12-month time frame, it is probably best that it is not exposed to the stock or bond market at all. As you know, there are numerous risks that cause the stock market to go up and down every day. So, when you have a shorter time horizon and will need your money sooner than later, why would you expose it to the chance that it could be less? This is especially important when it comes to folks that are looking to retire soon. We saw this take place during the Great Recession of 2008-2009 and as recently as the crash when COVID first entered our lives. Thankfully, the market recovered rather quickly but, what if it didn’t?
Your time horizon helps dictate how your money should be used and allocated in the investment world. When you are approaching the time when you will need to access your money for retirement, it’s probably a good time to consider reducing your exposure to the stock market. At this stage, you are most likely out of your growth phase and will be entering the income/capital preservation phase of your investment profile. By knowing when you will need your money, you can understand that you may not need to own a portfolio that is geared towards growth. This is how people get hurt and blow up their retirement. In 2008-2009 a portfolio worth $1,000,000 could have easily become worth $600,000. So, if you needed $50,000 a year for retirement and you were not invested properly, you just lost 8 years of money in that scenario. Now it’s impossible to completely eliminate down years but by being invested properly you can hopefully cushion the blow. This is why investing creates a lot of stress for everyday people which brings us to our next consideration, risk tolerance.
Your risk tolerance is easily described as how much money would you be willing to lose in order to achieve a certain level of gain. Younger people often have a much higher risk tolerance because they have a longer time horizon. Since they won’t be needing the money immediately they are able to withstand some of the bigger ups and downs than someone that may need their money three years from now. Outside of that, there are some investors that just absolutely cannot stomach seeing their portfolio drop 10%+ in a bad year. If you are an investor that has a moderately-conservative risk profile but 80% of your portfolio is exposed to the stock market, something is wrong there.
Investing is a lot more than just picking the right positions to generate the best returns. It takes planning aimed at an individual’s goals. Time horizon and risk tolerance will always be factors specific to that person. What may be great for one person could be horrifying for the next. Whether you are just starting to invest or review your portfolio annually, these should be two of the questions you ask yourself to hopefully build the appropriate investing experience.