Monday, June 28, 2010

Why the Notion of “Risk Tolerance” Is a Complete Myth

Why the Notion of “Risk Tolerance” Is a Complete Myth 

If you have encountered a conventional financial advisor, you have probably heard about the concept of “risk tolerance.” This basically refers to the level/degree of risk you – as an investor – can and should bear with your invested funds.

The major consideration in determining this so-called “level” is your age, which relates to how long it will be before you begin accessing your invested dollars for their intended purpose – most likely, retirement income. The supposed allocations are often already computed and charted out for you in colorful pie charts or via computer software that tells you the desired percentages of stock, bonds, cash, etc. your portfolio should contain.

The generally accepted wisdom – with which I vehemently disagree – is that younger investors, who have longer time horizons, can and should take more risk by investing a larger chunk of their money (or, in some cases, everything) in stocks, while older investors who are nearing retirement, on the other hand, should be more conservative by tilting their allocations more toward bonds and the like. There are dozens of models out there. Perhaps you’ve even answered a few questions via the Internet, in a brochure, or from your financial advisor to arrive at your personal suggested “risk tolerance model.”

I completely disagree with the bizarre idea that it’s OK, based on someone’s age and the length of time before they will access their funds, for them to take more or less risk. Just because an investor is, say, 35 years old today and plans on retiring 30 years from now, it’s a perfectly good idea for them to be heavily invested in stocks? Really? That’s the only meaning you can derive from this kind of advice.

Can anyone say or even imply that the risk inherent in investing in stocks dissipates with time? Absolutely not. The only explanation these so-called advisors usually offer for advocating such a position is that since they have so much time, even if this 35-year-old takes a huge hit (which happens more often than you might think), there will be enough time for them to “recover.” Says who? Can any of those advisors promise that such a recovery will actually take place? Does anyone have even the way of knowing when the stock market will dip? Of course not! So how can they then promise recovery?

You probably know someone – or have heard horror stories from people – who followed these “risk tolerance” maps and whose portfolios still today remain crushed by the market’s recent plunge. If these risk tolerance models work so well, why are people still suffering the effects of the big market shift? Some investors may in fact “recover,” but many will not. As an investor, you must constantly remind yourself of the fact that no financial guru can accurately predict the future of the stock and bond markets, regardless of how savvy or convincing they may appear to you.

Pursue a Strategy That Reflects Reality – LINK Your Portfolio to the Stock Market Instead

By linking your portfolio to the markets, rather than investing directly in them, you first protect all of your principal dollars. Then, when the market does well, your portfolio gains – up to a contracted cap – and those gains are locked in. But when the market plunges – the timing of which no one can predict – your investments are safe because your portfolio is not tied to the market’s risk and volatility.

What a beautiful option – and above all, it’s much more realistic than those fancy gambling gimmicks that could potentially destroy your retirement. Think about it for a moment and ask yourself where the portfolios of millions of devastated investors would be today if they had pursued this proven strategy.

My question for those advisors who continue to aggressively teach “risk tolerance models” as the solution for investors is this: Why in the world should an investor take such a risk and potentially lose a large percentage of their investment when you know perfectly well – or should know – that there is no guarantee they’ll ever gain it back, let alone grow it? Especially when such a risk is completely unnecessary? 
Call us today at 301-949-4449 or visit us on the Web to schedule your complimentary consultation. We will evaluate your needs and help you explore the best options for you - none of which involve pursuing a risk tolerance model.

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