The Learning Centre:
A balanced portfolio that reflects your risk tolerance.
Do you know how much risk you’re willing to take on in order to achieve your investment goals?
Investment experts agree that one of the most important things to consider when developing an investment strategy and a balanced portfolio is your risk tolerance. So here’s a question: Do you know how much risk you’re willing to take on in order to achieve your objectives?
You can measure your risk tolerance in financial or emotional terms.
There are two ways to measure your tolerance for risk. First, there’s the financial measurement. This should reflect your time horizon, income, liquidity, and net worth. (And as an education member, you should include their pension plan when considering their financial resources). Generally, the more you have of these things, the more risk you can assume, because you have a greater capacity to recoup any losses.
Why is your time horizon – the time you have before you’ll need the money you’re investing – so important?
Say you have 25 to 30 years before you take that long retirement so many education members enjoy. That’s a lot of time to recover from any downturns in the stock market. Historically, the market has increased over time, so you can invest more aggressively in things like stocks or equity mutual funds. If you have less time to invest – and therefore less time to recover if the market has a sustained period of decline – you’re less likely to invest aggressively.
What are the risks of investing in mutual funds? Read more in our Mutual Funds 101 series.
Your income and net worth also affect your risk tolerance. “Ask yourself, if I lost 20% of my wealth this year, could I still meet my financial goals?” says Educators Certified Financial Planner professional, Dan Martonfi. “A younger investor has time on their side. A high-earning investor has excess cash flow, and a high net worth investor has assets that can be rebalanced. They all may be able to withstand the loss and ultimately see a positive return in the future”. An older investor, or one with minimal assets or cash flow, should have a portfolio of more stable investments such as bonds or fixed yield investments, which are less likely to react to volatility in the stock market.
But as anyone who’s ever lain awake nights when the market is volatile will tell you, there’s a second measure of your risk tolerance, which is the emotional component. This can cause investors to make irrational decisions, be it selling when the market has fallen 15%, or buying when the market is at its peak. If you lose sleep worrying when the market is volatile, it could be an indication that a less aggressive portfolio – one less sensitive to the market’s ups and downs – is right for you.
Getting the asset allocation that reflects your risk tolerance requires professional advice.
It takes specialized education and experience to pick investments that reflect an investor’s risk tolerance and goals. Your Educators Certified Financial Planner professional can ensure that your portfolio meets all your investment needs, such as ensuring your cash flow during the summer, and making sure you save enough for your retirement (which is often longer for education members, remember). And once that’s done, it’s just a matter of staying focussed on your long-term investment strategy, right? Right…and wrong.
Portfolios need reallocating as well as rebalancing.
Life has a way of throwing you a curveball. Your spouse loses their job. You have collective bargaining issues, and your salary is disrupted. The furnace dies. You suddenly realize retirement’s only 10 years away.
When you experience a major life change, you need to ensure your portfolio is continuing to reflect your needs.This is called reallocating – altering the mix of assets to be more appropriate for your new circumstances and objectives. For example, education members nearing retirement may want to decrease the amount of higher-risk investments they hold, and increase the amount of income-producing investments. This is why you and your Educators Certified Financial Planner professional should be looking at your portfolio whenever you experience a major life change.
Regular rebalancing of your portfolio is important.
As a result of the normal ups and downs of the financial markets, the asset allocation within your portfolio will shift and change. This is because different assets will have different returns. If, for example, the stocks within your portfolio are growing at a faster rate than other investments, the percentage of stocks will increase and your asset allocation (or balance within your portfolio) will no longer be the same. If left unattended, your portfolio could become more aggressive than you intended.
One approach to keeping your portfolio allocation in line is to rebalance your portfolio once a year, as part of an annual financial assessment. Or, you may want to rebalance when your portfolio’s strongest asset class exceeds your target allocation by a specific percentage, say 10% or 15%. Again, your Educators Certified Financial Planner professional is your ‘go to’ source, one who can help to ensure your portfolio maintains the balance that’s right for you.
One way to easily ensure your portfolio maintains its balance is with Educators Monitored PortfoliosTM, which are available in four different asset allocations, reflecting different levels of risk tolerance. The portfolios are chosen by professional mutual fund portfolio managers, who will automatically rebalance them on a regular basis to maintain their original asset allocation. This is a real time-saver for you.
So you can see the importance of understanding your risk tolerance, choosing investments that reflect this tolerance, and ensuring your portfolio maintains its original balance. These are all critical to ensuring your investments work for you. Thankfully you have expert advice close at hand in your Educators team.