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Investment Risk Tolerance


10 Personal Financial Planning Steps in the Right Direction

This is one of the “10 Steps in the Right Direction” that make up The Pasadena Financial Planner‘s personal financial planning and personal investment management process. For a summary of these ten steps, see “Your Family Financial Planning“. To find an in depth article for each step, just click the Sitemap link at the top of this page. Also, you can reach us by using the contact form below. Please enjoy reading this article. Thank you!

Step 4 – Take personally appropriate investment risks

Investors with different levels of risk tolerance are more satisfied with investment strategies that are better aligned with their risk preferences. Differences in risk tolerances mean that more risk-averse investors are personally more satisfied with a lower risk portfolio despite its lower expected returns. The must consume less and save at higher rates, but their path to success is more certain.

Only some can live with the greater risks associated with the potential for higher returns

Everyone would love both low investment risk and high investment returns in the same portfolio, but such portfolios are just pipe dreams. Investing is all about intelligent and sensible exposure to investment risks. Investing means that the investor is willing to incur risk in exchange for the possibility of a higher future payoff. Unless there is a chance that you will lose some or all of your capital investment, you simply are not investing.

Rational investors expect increased returns for taking on investment risks. Investors have rational expectations for positive risk-adjusted payoffs. Current securities market prices reflect the current risk consensus and carry a discount compared to expected future values.

On average, stock and bond investments have paid investment risk premiums historically. These premiums have fluctuated and have been thoroughly unpredictable until after the fact. Investors who have consistently stayed in the market have earned higher returns over time. While the desire to avoid investment risk is understandable, investment studies have demonstrated that efforts to time the market by jumping in and out have not been successful.

Investors need investment strategies aligned with their personal psychology and risk tolerance

Investors with different levels of risk tolerance are more satisfied by the expectations associated with investment strategies that are better aligned with their risk preferences. Differences in risk tolerances mean that more risk-averse investors are personally more satisfied with a lower risk portfolio despite its lower expected returns. They must save at a higher sustained rate and consume less along the way, but their financial strategy is more certain.

Less risk-averse investors are more satisfied with portfolios characterized by higher risk and higher expected returns. In relative terms, they can consume more and save at a lower rate, because they are expecting and depending upon higher asset growth. However, the success or failure of their financial plan is subject to greater variability, since they have a greater dependence on more risky investment assets, which may or may not deliver the returns that they expect.

Because investing is inherently risky, individuals should understand their probable response to risk factors that actually do materialize. Risk tolerance is an issue of personal psychology and will determine whether an investor will adhere to and sustain an investment strategy during more difficult economic and investing times. When markets are performing poorly and fears are high, an inappropriate alignment between an individual investor’s portfolio risk or volatility and his or her risk tolerance can be very costly.

In such circumstances, some less knowledgeable and unprepared investors may take inappropriate actions that can be explained by their personal psychology at the time. However, these mistaken actions can be inappropriate for the financial market situation and highly detrimental to their long-term financial goals and welfare. Some investors may panic and sell when they did not have to, only to see the market recover, while they subsequently remain on the sidelines with a dramatically diminished financial asset portfolio. Portfolios with different risk and return characteristics are simply better for certain investors depending upon their tolerance for risky investments.

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Pasadena Investment Adviser

Pasadena Investment Adviser

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Larry Russell, Managing Director

MBA – Stanford University, MA – Brandeis University, and BS – M.I.T.

Lawrence Russell and Company Pasadena, California 91103

(626) 399-9579

A California Registered Investment Adviser — Certificate 133101

KNOWLEDGE — OBJECTIVITY — HONESTY — DILIGENCE — SATISFACTION

A truly independent financial planner and fee only investment advisor

(Concerning my compensation, I charge only on a fixed fee or hourly fee for service basis, and only under a contract agreed upon with you. I do not charge any asset fees. Furthermore, in the interest of avoiding all conflicts-of-interest, I do not accept compensation or commissions of any type from the financial industry.)

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