The Rewards of Understanding Risk

Although we may not realize it, all of the decisions we make involve some calculation of risk versus reward. From simple everyday choices like getting lunch at the usual spot or trying someplace new, to more complex decisions like how to invest for retirement, our brains are wired to view decision-making as the process of calculating potential reward and inherent risk. The more complex the question – and the greater the potential impact of an undesirable outcome – the more likely we are to weigh these decisions consciously.

Of course, the risk of a bad lunch involves little material loss – the risk of losing a significant portion of your retirement fund carries a lot more weight, and consequently, the choices people make when considering major life decisions like retirement planning involve a more involved risk / reward calculation. This process can be overwhelming, especially if you have only a passing idea of what your own true tolerance for risk in any given situation is. That’s why BFA Wealth Management starts our collaborative financial and investment planning process with an assessment of each of our clients’ true tolerance for risk. The process is easy to complete, simply requiring a few answers to a step-by-step questionnaire. Behind that user-friendly interface, however, is a powerful algorithm designed to inform each individual who takes the assessment exactly where they stand on the spectrum of risk tolerance in the arena of investing and retirement planning.

Taking this assessment requires very little time, as the questions given are either very specific (such as your age and desired retirement age) or multiple-choice, giving you two options to consider – one which involves a certainty, and one which involves risk and uncertainty, with possible outcomes involving loss or gain. By walking you through this process, our system is able to determine what your true tolerance for risk in financial investment is, and in turn, this allows us to tailor our advice specifically to you.

Of course, we also take into account many other factors that can affect your investment plan. For example, what will your anticipated spending needs be between now and retirement? Are there any major events you want or need to plan for, such as a wedding or a big vacation? How long is your time horizon – the period you plan to hold your investments? Do you have any important family obligations to plan for, such as the care of an elderly parent? All of these important questions can affect your investment and retirement plan by themselves, which makes knowing your true tolerance for risk so critical.

Tolerance for risk in investing runs the gamut from conservative to aggressive - for example, someone with a large amount to invest and a long time horizon may be able to accept a more aggressive strategy since they have a longer period of time to recover any potential losses. For someone with a shorter time horizon, however, this may not be a good approach, as the need to recover a loss could extend that individual’s time horizon, potentially increasing their retirement age - or perhaps a loss could also force that individual to consider changes to their anticipated spending. Examples like these highlight just a few of the factors that the process of calculating true risk tolerance encompasses, and furthermore, even if an investment strategy misaligned with your risk tolerance happened to work for you in the long run, while that strategy was in motion, you may very well find yourself constantly concerned about missing out on upside potential or facing a devastating loss from overexposure to risk. This is one area where a plan and a portfolio keyed to your risk tolerance can make a big difference; helping to eliminate stress from your financial life. Your financial plan should be a valuable tool for organizing your life and helping you work toward your goals, not a constant source of worry.

You know you want to achieve success as you define it, but there may be many paths to choose from, and those that make you feel uneasy may contribute negatively to your satisfaction with your plan and your confidence in your financial choices. Armed with your real tolerance for risk, however, BFA Wealth Management can help you make a plan with your best interest – and your comfort level with varying investment strategies – in mind.

If you want to learn more about how your true risk tolerance helps to guide your investment strategy, take a minute to read this article about investing with your comfort level with risk in mind, and this article about rebalancing your portfolio to keep it in line with your risk tolerance.

If you are interested in learning your true tolerance for risk, or if you’d like a second opinion on your current portfolio, contact BFA Wealth Management today. We offer complementary, no-obligation investment analysis to show you how we may be able to help, and we can work with you to make a financial plan and investment strategy designed with your real life - and your true, calculated risk tolerance - in mind. Let’s talk.