It’s foolish for an investment planner to complete a simple risk tolerance questionnaire and cherry pick an investment portfolio – it’s simply not enough information which is why we base every client’s investment plan off their financial plan.
There are three components to every great investment plan – two of which are factors of your financial plan and one is simply a subjective “guesstimate”:
- Risk Tolerance. This is a subjective “guesstimate”. Your risk tolerance is nothing more than how emotionally stable you are through bad market cycles. Unfortunately, until you live through those bad market cycles you won’t really know how “risk tolerant” you are. In good markets your risk tolerance is higher, and in bad markets your risk tolerance plummets. Your risk tolerance is a small factor in your overall investment plan, which is why we focus on your risk capacity and risk required – which are factors of your financial plan.
- Risk Capacity. Your risk capacity is the amount of investment loss you can withstand and still achieve your financial goals. You may be tolerant of a 20% drop in a bad stock market, however your financial plan may be completely derailed! We work to match your risk capacity with your financial plan to make sure you can withstand those inevitable market drops without your financial plan imploding!
- Risk Required. A 20% drop in your investment portfolio may be completely unacceptable to you emotionally, but that level of risk and volatility may be required to achieve the returns necessary to meet your financial goals. If your financial goals are so lofty your investments must produce a return of 4% over the inflation rate, you must be willing to accept an investment portfolio with a commensurate level of risk OR reduce your financial goals OR increase your savings.
Any quality investment plan must be driven by your ultimate financial needs and desires for the future. Anything less than a comprehensive personal financial plan will inevitably put you at greater risk of not achieving your financial goals.