Sandra Foster, financial author and president of Headspring Consulting, says taking on higher risk 'can pay off in higher rates of return over the long term.' But investors need to first establish their risk tolerance by taking a questionnaire.Deborah Baic/The Globe and Mail
Every investor, regardless of age, lives in the shadow of a four-letter word: risk.
The challenge is the same whether you’re 30 and just starting to put away some money or 60 and planning for imminent retirement. How much risk can your portfolio tolerate – and how much can your stomach take?
Risk is where financial planning meets psychology, and it isn’t always a pretty place. Individual risk tolerances will vary, because it’s partly a matter of personality.
But there are a few principles that can help investors deal with risk at both 30 and 60, says Robert Mark, portfolio manager at Raymond James Ltd. in Toronto.
“Generally, the younger you are, the more risk you can afford to take and the more risk you should take, especially in the current market," Mr. Mark says.
Knowing how much risk you can tolerate isn’t necessarily easy, acknowledges Sandra Foster, Toronto-based financial author and president of Headspring Consulting Inc.
“It can be difficult for some people to imagine what risk can feel like. The tradeoff for accepting higher levels of risk is that it can pay off in higher rates of return over the long term,” she says.
Whether you’re 30 or 60, Ms. Foster recommends that investors take an investment tolerance questionnaire – a standard tool offered by financial advisors and investment firms.
“These questionnaires ask a number of questions to measure your attitude to risk in general, and your ability to tolerate the ups and the downs of your investments. Most people handle the ups well; it’s the downs that can tell the story,” she says.
“The questionnaire considers your age, investment experience, general financial situation, and other factors. When your risk tolerance has been determined using the answers to the questionnaire, the next step is often to build an investment portfolio using the recommended asset allocation,” Ms. Foster explains.
“Since these factors change over time, it is very likely that your risk tolerance will also change, so you should periodically review your risk tolerance questions. You should also rebalance your portfolio back to your target asset allocation so it does not become unnecessarily risky,” she adds.
Asset allocations are usually different when you’re 30 than when you’re 60, Mr. Mark says.
“When you’re younger, your portfolio should mostly be equities,” he says.
As anyone following the markets since the end of 2018 can attest, equities can take investors on a bumpy ride. While markets do tend to go up over the long term, the TSX, for example, was down about 1,000 points from a year ago in mid-January, and that wasn’t even as bad as it was earlier in the month.
This is easier to take at 30, and it makes sense to go for the long ride at that age, Mr. Mark says.
“A 30-year-old who is years to retirement should have a high appetite for equities.” He recommends dollar cost averaging – a strategy by which an investor buys a fixed dollar amount of a particular investment on a regular schedule, whether the price goes up and down.
“If you make regular contributions, even if you take higher risk you’ll likely get a higher rate of return,” Mr. Mark says.
“Of course, when you’re older it’s a different story.”
While experienced investors generally understand that the more risk they take, the more return they should expect, “it also means that in a down market you should expect more downside participation,” says Paul Shelestowsky, senior wealth advisor at Meridian Credit Union in Niagara-on-the-Lake, Ont.
That’s where the test of an investor’s risk tolerance comes in – the one that the questionnaire tries to anticipate.
It’s best to take calculated risks based on how much you think you can handle if your investment goes south – emotionally as well as financially, Mr. Shelestowky says.
“My motto is to be risk diverse, not risk averse,” he says. There’s an old adage which says that the percentage of equities an investor should hold in stocks is “100 minus your age.” In today’s lower interest rate environment, most advisors suggest adjusting this to 110 minus age or even 120, Mr. Shelestowsky says.
This adjustment is because at say, 60, the traditional rule would have an investor keeping 60 per cent in bonds, and this may not produce enough for a stable retirement. “Fixed income has not been paying enough return to generate the income required,” Mr. Shelestowsky says.
At either 30 or 60, investors should still consider the psycho-emotional factors involved, says Markus Muhs, investment advisor and portfolio manager with Canaccord Genuity Wealth Management in Edmonton. Different people will often have additional sources of income beyond their investments too, and these should be considered as well, he says.
“A 30-year-old with no investment experience, for example, should take less risk than a 60-year-old with a lifetime of investment experience and a defined benefit pension covering their income needs,” Mr. Muhs explains.
The rules for 30 and 60 year olds aren’t ironclad, Mr. Muhs adds.
An older investor, for example, “might have learned that all market volatility eventually passes, and thus could take a lot of risk,” he says.
“Almost all my clients over 60 have at least some risky emerging markets funds in their portfolios. Likewise, many clients with 30-plus years to retirement have bonds in their portfolios – unnecessarily, I think, but to calm their emotions and prevent them from making emotional mistakes.”