When it comes to investing, risk is an important factor to consider. Most sources suggest that a low-risk portfolio should contain stocks of between 15 and 40%, with the rest of the portfolio made up of lower-risk asset classes such as bonds, money market funds, real estate funds, and cash. Before deciding which investments are right for you, it's important to assess your risk tolerance and capacity. On average, stocks have higher price volatility than bonds because they don't offer the same protections and guarantees.
Bonds offer creditors greater bankruptcy protection than equity shareholders, as well as consistent promises of interest payments and return of capital even if the company is not profitable. The 5% rule is a simple example of how an investor can create their own portfolio of individual securities. The investor could pass the 5% rule by creating a portfolio of 20 shares, each at 5%, for a total portfolio of 100%. Young people who are saving for retirement have high risk capacities, while those who are about to retire have lower rates but still need to take some risk to ensure their money lasts.
Risk tolerance relates to how you feel when the market is volatile and is usually less important than risk capacity. However, if your risk tolerance is so low that there's a chance you'll change your plan when the going gets tough, it's important to take into account. It's useful to regularly audit your portfolio to make sure it's in sync with both your risk tolerance and capacity. Investors who don't intervene may be surprised to discover that the contents of their portfolios have changed since they initially made their allocations, even if they haven't put a finger on their portfolios.
This is because higher-risk assets tend to earn more than lower-risk assets over time; if left unattended, they will grow as part of a portfolio. In weak stock markets, investors may want to increase their capital allocations to achieve their goals again. For retirees, it's usually recommended to keep one or two years of living expenses in real cash instruments. For those who are still working, three to six months of living expenses in cash is the baseline, but if you're a contractor, earn a high income, are your household's only source of income, or work on a more specialized career path (or all of the above), one year of cash should be kept as a continuous mattress.
Another risk that is often overlooked but easy to control is overpaying for investments. Unlike overly aggressive participation that only costs you when stocks fall, overpaying takes a blow to your returns year after year. Investors seem to realize the importance of making their investments cheaper, as evidenced by the huge inflows of low-cost indexed products, especially exchange-traded funds. The Morningstar Medalist funds have been named as such, with spending as a key emphasis.But don't stop doing product-level cost due diligence; also take a close look at brokerage fees, account maintenance fees, and advisory fees you're paying for your various accounts.
Some of these expenses may be unavoidable (and the money invested in good advice may be worth it), but you need to make sure you're getting value for money.Finally, the mother of all portfolio risks is running out; either because you didn't save enough during your working years or because you retired too soon when you retired. If you're in accumulation mode, the most important part of assessing your portfolio's risk is to check if your current portfolio balance along with additional contributions expected over your time horizon help you achieve your financial objectives.General rules can be a good starting point; if you're a younger accumulator, the benchmarks provided by Fidelity Investments can help you determine if you need to increase your contributions.
