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Investment Risk: How Much Should You Tolerate?

Posted by Larry Jones on Jan 23, 2018 9:30:00 AM
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Are You a Risk-Taker?

Mr. Allen is the CEO of a large manufacturing firm, which has done very well over the last ten years. Lately, in considering expansion plans, it was brought to his attention that an attractive opportunity was available in another country for the location of the new plant. Labor costs would be much lower, and access to raw materials was also easier there, and he could count on a much higher return on investment.

On the other hand, this particular country has a history of political instability. In fact, powerful factions in this country were actively working toward political revolution and a committment to nationalizing all industry inside it's borders, effectively taking over all foreign investments.

Should he locate the new plant in this country? How will Mr. Allen decide?

How about you? What would you do?

The answer you'd give reveals a lot about your personal attitudes toward taking risk.

Two World Views

I personally have clients who encompass all levels of risk in their investment portfolios. I even know one couple who have all of their assets tied up in the currency of Iraq, the Iraqi Dinar (no, this was NOT advised by me). On the other hand I have folks who will accept absolutely no risk when it comes to their investment portfolio (Note: there is no such thing as zero risk in this life, but you can get very close to it!).

You may be interested in taking a look at the two types of people, the monetary "risk averter" and the "risk taker."

Risk Averter

  • sees risk as danger
  • overestimates risk
  • prefers low variability
  • will always assume the worst-case scenario
  • is pessimistic
  • likes structure
  • dislikes change
  • prefers certainty to uncertainty

Risk Taker

  • sees risk as a challenging opportunity
  • underestimates risk
  • prefers high variability
  • will always assume the best-case scenario
  • is optimistic
  • likes ambiguity
  • enjoys change
  • prefers uncertainty to certainty

These are the two extremes. Real people usually fall somewhere between the two. The challenge for the investor, and for the financial planner, is to determine which level of risk you are comfortable with, and to base investment decisions on.

You Might Be Surprised...

which camp you'd fall into. Just because you're into extreme sky-diving and weekend bull-riding doesn't mean you are willing to take risks with your money. There is an inviolable rule, however, that assumes that the more risk you are willing to take with your assets, the more potential return you may expect to get for it. 

I'm going to end this blog by answering the question in the headline: how much investment risk should you tolerate?

The answer is....(drum roll here):

Not one bit more than is necessary to obtain your investing goal. In other words, don't take any more risk than is necessary. Anything more is unwise.

When it comes to your portfolio, are you wise? How would you quantify your decision? Can your stockbroker quantify it? My experience in portfolio analysis has taught me that the stockbroker usually has one idea of how much risk is acceptable and their client has quite another one. Are you aware of how much risk your portfolio is exposed to? If not give me a call. It's something you need to be aware of.

Until next time,


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Topics: investment risk

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