Investment down risk as you get older. There are very few things that the majority of financial advisors and professionals agree on. However, this is one of them. Pretty much all financial professionals agree that as you get older, you should adjust the risk of your investments downward to more conservative investments. It’s not a terribly difficult concept but there are a few things I should explain.
(1) Aggressive Investments When You Are Young
When you are younger, most financial advisors will put you into more aggressive investments. However, this will look a little (or a lot) different for everyone. Just like no two people look the same, neither will their risk tolerance. But before I go on any further, let me briefly explain what risk tolerance is.
ALL investments have some sort of risk that is correlated with some sort of reward.
For example, if you invest in a US T-Bill, there is very little risk. And because of this, there is very little reward as well. US T-Bills pay very little interest.
However, if you invest in a really young company that is in the tech industry there is a LOT of risk. But because of this, you have the potential to have a really big gain. But you might also have a really big loss as well.
Risk and reward go hand in hand. You can learn more about how they work here.
Now that we have that out of the way, let me continue.
When you are young, most investment portfolios will consist of a lot more aggressive (risky) investments. This is because of two reasons:
- You need to have some portion of your portfolio devoted to investments that can get you a really big gain.
- If you have some investments in your portfolio that happen to have a big loss, you have a long time to recover from those losses because you are young.
Mike and Nancy
It’s important to note that just like no two people are the same, no two portfolios will be the same either. For example, Nancy is 31 years old and might be okay with a risk level of 8 out of 10 while Mike is also 31 years old and might be okay with a risk level of 6 out of 10. Neither of these people are wrong or bad, they are just different.
But remember that because risk and reward are correlated the person with the 6 out of 10 risk tolerance (Mike) will generally have less gains than the person with a risk tolerance of 8 out of 10 (Nancy).
As you can see from the example above of Mike and Nancy, Mike is pretty consistent. He doesn’t have any big losses or any big gains. It is a lot more of a steady increase.
But as far as Nancy, she has some really big gains and losses in her portfolio. But because of the risk that she is taking, over time, her portfolio will outperform that of Mike’s.
Now let’s go over why Nancy (or anyone) would want to adjust your risk downward as you get older.
(2) Conservative Investments When You Are Older
As you get older, you will need to start adjusting your risk downward. That is primarily because you don’t have the time to recover from a big loss of a risky investment.
Think about it like this. If you were going to retire in 2009 and your retirement portfolio was invested aggressively, you would have had HUGE losses just one year before retirement. That would suck!
In this example, a person who had $1,000,000 in their retirement account would have seen it drop to somewhere around $450,000 in 2008 alone (beta of 1.5).
If someone who was invested in the S&P 500 alone (this is generally considered a medium aggressive strategy) would have seen their retirement account go from $1,000,000 to $630,000 (beta of 1.0).
BUT someone who had transitioned their portfolio into a more conservative nature would have had their account go from $1,000,000 to $815,000 (beta of 0.5).
If you don’t know what a beta is, don’t worry about it right now. 🙂
That is why adjusting your risk downward as you get older is SOOOO important!
The point is, that sometimes when the market goes down, there is nothing that you or me can do about it. The only thing that you can do is to keep riding the roller coaster.
Remember: The only one who gets hurt on a roller coaster is the one who jumps off.
At the same time, if another person has the same $1,000,000 portfolio but is much younger, they can afford to take the bigger loss because they will have several years to recover from it.
Final Thoughts
Losses are sometimes going to happen. It’s just important to shield yourself by adjusting your risk downward as you get older.
Everyone’s risk tolerance will look a little different as I’ve stated before. But as a rule of thumb, you should generally dial down the risk that you take in your portfolio the closer that you get to retirement.
In my time as a financial advisor, I have worked with people in doing this. I have helped people dial back their risk by half or more depending on how close they are to retirement and how much risk they are comfortable with taking.
And I will do the same thing with my portfolio when the time comes. Right now, I am in my mid-30s and am invested rather aggressively because (1) I am young and can recover from any losses that I might have and (2) generally have a pretty high risk tolerance.
Also remember that if you are working with a financial advisor and they try to put all of their clients into the same portfolios as a one-size-fits-all approach, RUN FOR THE HILLS! 🙂
I am here to help!
You can do this!
Until next time!
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