RIDING THE FINANCIAL ROLLER COASTER

WRITER: THOMAS H. RUGGIE, CHFC, CFP

Just as you prepare for bad weather by carrying an umbrella, investing wisely for retirement includes understanding your risks, and how much risk you’re willing to take for the chance at higher returns.

The phrases “risk capacity” and “risk tolerance” are often used interchangeably, when, in fact, they are quite different.

Risk capacity is a measure of your financial ability to sustain risk.

In a practical financial planning context, a risk capacity analysis correlates how much money and assets you have, how much income you will need from that pot of money, the time horizon when you will need it, and how long you’ll need it for.

As an example, if you need to fund retirement withdrawals of $40,000 a year from assets of $1 million starting 10 years from now, you would have a very high capacity for risk. You will still have ample means to sustain your retirement goals even if you were to experience some years of portfolio underperformance.

But if you need to fund retirement withdrawals immediately at $40,000 a year from an asset base of $500,000, you have a much smaller capacity for risk. Your financial plan is more likely to fail with anything less than strong portfolio returns from the very start. Therefore, you would have very little capacity to take risks.

“Risk capacity” is all about your financial ability to sustain underperformance of your investments in pursuit of higher overall returns, without an unacceptable loss of quality of life.

Meanwhile, “risk tolerance” measures your willingness to enter into such a tradeoff in the first place. It measures your ability to handle risk emotionally, evaluating your willingness to take on the risk of receiving lower returns in exchange for the possibility of earning higher ones.

Financial risk capacity and emotional risk tolerance create the foundation on which an overall portfolio can be created to determine your appropriate investment solutions.

DO-IT-YOURSELF RISK TOLERANCE

Investors who try to “time the market” put themselves at risk of missing exceptional returns. The practice may negatively impact an otherwise sound investment strategy.

Higher exposure to the right risk factors can lead to higher expected returns. However, it’s important to follow a long-term strategy in good times, and to continue to evaluate that strategy so it serves you during hard times.

Instead of only asking how much risk you should take within your portfolio, you may want to ask how many years are left before you start withdrawing at least 20 percent of your investments, and what is the worst 12-month unrealized percentage loss you would tolerate for your long-term investments?

So what steps should you take, with the help of your financial adviser, to protect your assets?

• Review your investment strategy with an emphasis on risk. You know your investment strategy is a function of your time horizon, goals, and tolerance for risk.

• All investors need protection from three basic risks: First, there’s market risk, the possibility that events in financial markets may lead to a decrease in the value of your investment. Investors in bonds and bond funds are subject to interest rate risk. Finally, those who try to preserve money by just investing in bank certificates of deposit face inflation risk – when inflation outpaces interest, you have diminished purchasing power.

• Recommit to saving. Sticking with your retirement savings plan ensures you invest a fixed amount at regular intervals, resulting in an optimal average cost per share over time.

SO HOW MUCH RISK IS TOO MUCH?

How much risk you decide to take depends on how much volatility you can tolerate. Think of volatility as a change in value of your account. Generally, while stock portfolios experience greater short-term swings in value than bonds, there is an important tradeoff. Equities (stocks) reward you with greater potential for long-term gains.

Another major factor to consider when thinking about your risk tolerance is how long it will be until you expect to tap into your investment account. If you have three decades until retirement, you may be better able to stomach a market downturn. You’ll have plenty of time to recover. Conversely, if you are in, or approaching, retirement, you have less time to benefit from the market’s eventual upturn and may worry more about a down market.

Overcoming risk takes sound financial planning. Having the advice of a good financial planner could help you weather potential storms.

THERE’S AN APP FOR THAT

A new app called Acorns allows consumers to round up credit card purchases and invest the difference in low-cost exchange traded funds. For example, if you spend $8.50 on lunch, the remaining 50 cents is invested. With Acorn, you connect as many debit or credit cards as you’d like along with a checking account. It doesn’t sound like much, but Acorns says that its current users invest $30 to $180 a month in “roundups” alone.

Source: businessinsider.com

THOMAS H. CFP

Management. With more than million in assets under management, he has Most as one of Barron’s Advisors.

THOMAS H. RUGGIE, CHFC, CFP is the founder of Ruggie Wealth Management. With more than $425 million in assets under management, he has been ranked among the nation’s 50 Fastest Growing RIA Firms, the Top 100 Wealth Managers, Top 100 Independent Advisors, Top 40 Most Influential Advisors, and as one of Barron’s Top 1,000 Advisors. truggie@ruggiewealth.com