Wiser Financial Advisor – Choosing Your Risk Number
Hi, Everyone. Welcome to the Wiser Financial Advisor with Josh Nelson, where we get real, we get honest, and we get clear about the financial world and your money.
This is Josh Nelson, Certified Financial Planner and founder and CEO of Keystone Financial Services. We love feedback and we’d love it if you would pass it on to me directly: email@example.com . Also please stay plugged in with us, get updates on episodes and help us promote the podcast. You can subscribe to us at Apple Podcasts, Spotify or your favorite podcast service.
Let the financial fun begin!
This is episode #51, so we’re coming up on one year of the Wiser Financial Advisor. It’s been a lot of fun for me to learn with you, because really, that’s the whole point—that we’re learning it together, and we’re not just learning based off what’s in the news today, because that’s a dime a dozen. We’re looking at historical principles and things that are time-tested from people that have walked before us.
Warren Buffett said, “Be fearful when others are greedy and greedy when others are fearful.” I think Warren Buffett is someone to listen to, because not only is he one of the most successful investors of all time, but the guy is over 90 years old right now and sharp as a tack. He goes to work every day still and does a lot of reading and thinking and analyzing the market. He is still very actively involved.
So, the reason I’m thinking about this right now is because the market is regularly hitting all-time highs. That’s the best time to start thinking about how much risk we’re taking in our own portfolios and how much risk we’re comfortable with so we can make changes if we need to while times are good. We know from experience that there’s going to be a time when things aren’t so rosy. Of course, there are always black clouds out there in the economy. There are always things that we can be worried about, but bottom line is that right now we are at all-time high, and it is a good time to at least take a pause and look at what we’re doing.
When we talk about risk, what are we talking about? What we’re not talking about is the risk associated with having all your eggs in one basket, because I think most of us know that’s a terrible idea. You don’t want to put all your money into one thing such as one stock or one bond or one property or one cryptocurrency. Putting all your money in Bitcoin or something like that would be crazy. I think most of us have the common sense to know it would be a really, really bad idea. We want to diversify risk and put our eggs into lots of different baskets.
Regarding risk, what we’re talking about is what’s known as volatility or turbulence in financial markets. If you’ve ever been on a plane, you’ve experienced turbulence somewhere during the flight. There’s going to be a little bit of turbulence at least. I’ve got a couple of good friends who are airline pilots, and I’ve asked them, “Does turbulence bother you? Does it make you nervous or scared or anything like that?” And they say, “No.” The only thing they’re concerned about is the comfort of the passengers. Turbulence is not a safety factor. Planes don’t crash because of turbulence, but it can be uncomfortable for the people in the back of the plane. I’ve been on some of these flights in the past where the whole flight is really turbulent and the plane is bouncing all over the place, the wings going back and forth. As a passenger, you’re wondering, “Are we going to make it safely onto the ground?”
Some people aren’t bothered at all because they are so used to it. They have a fairly high turbulence tolerance. Other people that don’t fly very often, might be white knucklers grabbing onto the armrests. They think the plane is going down because the turbulence is getting bad. So there’s a comfort factor that does need to be addressed, which is why pilots make an effort to change altitude or go around thunderstorms, because they really want the folks in the back to be as comfortable as possible and still get to their destination.
So getting back to investing, all of us have a risk number and it matches up with the turbulence that we’re willing to tolerate in our own portfolio. For example, look back to that time right after the pandemic hit and the stock market dropped over 30% within a couple of weeks. It was a very quick drop! A third of the market value was lost. Now, did things come back? Yes, absolutely. Things came back up, and it is important to note that the stock market has never gone down without coming back up.
A bear market is when the market goes down more than 20% and the bear market that we experienced in 2020 was relatively short. But going back to the financial crisis in 2008, 2009, the market dropped over 50% from top to bottom and it took a year and a half to get there, and it took at least a couple of years to get back to where we were before. Going back to the early 2000s, in 2000, 2001, and 2002, all three of those years the stock market was down double digits. Overall, it was down over half its value.
It’s important to take a pause, especially when things are good right now, to really think about what kind of experience we want. There’s a sleep-at-night factor with a risk number, and that’s really what we’re trying to approach.
So how do we figure out someone’s risk number? At Keystone we use this number with our clients—there’s a risk number that shows up on the website when they log in. And in fact, our clients choose their own risk number. We don’t choose that for them because it isn’t up to me to judge that. It isn’t up to me to tell you how comfortable you should be or shouldn’t be. It’s your job to tell me how much turbulence you’re OK with. Once you do that, we try to figure out what rate of return we’ll be trying to get that has some realistic chance of matching up and meeting your expectations.
So how to figure out what your risk number is? We use a tool that works on a scale of 1 to 99. Your risk number is going to be somewhere on that continuum. If you’re a one, that means you just want to keep your money in the bank, in a savings or CD or something like that which is FDIC insured. That will help you sleep at night. You won’t get any return, of course, right now. Interest rates are so low that there’s basically no return on those cash assets. However, if somebody really is a one—if that’s their risk number, they may not care about whether that account is paying a return. They might say, “You know what? That’s great. I don’t care if I make a rate of return because it makes me feel safe. I don’t want any turbulence whatsoever.”
Now, on the other end of the spectrum, someone might want to put everything into one stock or one cryptocurrency or one piece of property. That’s all crazy stuff we wouldn’t even want to consider for any of our portfolios. So to get more diversified would be a question of what types of asset classes we add into the portfolio. By asset class, I mean things like stocks, real estate, bonds. Those are broad categories of investment. You might remember that we had an episode a while back called the most important investment decision. And the most important investment decision is simply this: What mix of asset allocation are you going to have in your own portfolio?
So, the recipe for your portfolio needs to be customized to your risk number. That will determine how much turbulence you are comfortable with, and it also will determine what kind of rate of return you end up having. When figuring out your number, you could just pick a number of course, and some people like to do that. They just say, “You know what, I think I’m a 70.” Or “I think I’m a 60.” “I think I’m a 50.” Whatever that number is, we go with it. Some people just kind of pick a middle-of-the road number and say, “That’s where I want to be. I’ve always been a middle-of-the-road type of person, so that’s where I want to set.”
You could pick your risk number that way, or you could use a tool. We have a free risk assessment on our website, so if you go to www.keystonefinancial.com and scroll down, there’s a button that says Find out your number. That risk assessment is quick. It just takes you 5 minutes or so. It’s a scientific tool that gives you an objective look at answers you give that translate into a risk number. The people that designed this actually won a Nobel Prize for how they assess risk, so it’s actually a pretty good starting point.
When you take that risk assessment, it’ll be interesting. It will pop out with your risk number and we’ll get a copy of that too. We’d be happy to go over that with you just to give you a second opinion based off what you’re doing right now, making sure that your risk is in the ballpark, at least, for matching up with where your current investments are. No obligation there, just a free offer that we’re happy to talk through with you and help you understand what your risk number means and how that translates into an actual portfolio. I think that’s a good way to start, by using something that’s objective, something that isn’t going to be just you guessing.
When you take the test, remember that emotionally you might be in a bad mood, might be in a good mood. It could be morning or evening, could be after a glass of wine or before a glass of wine. The test could drastically vary depending on when you are taking it, so you might take it more than once. Your number might not match up. It’s possible that it would come back saying you’re a one, and you say, “No, I’m not, I’m a 60.” But it’s a way that we can determine a place to start with, to figure out if your risk is high or low or medium—and then figure out where your current portfolio is and really do a good, honest assessment of where all your holdings are and whether they match up.
If your risk number is not matching up with your portfolio, what are the consequences of that? I can think of two big ones. One would be that your portfolio doesn’t do what you expect it to do. People generally aren’t happy when their expectations aren’t met. You might not get the rate of return that you want. What I mean by that is, let’s say your portfolio and your risk tolerance are at 20, but you’re expecting rates of return that could only be achieved by a 70 or 80 type of portfolio. Clearly, you’re not going to be happy, so it’s important to make sure that your expectations match up with your risk number.
Your portfolio is really important because again, that is the most important investment decision. Almost all of your investment experience is going to be determined by how we mix the recipe here—what kind of asset classes and what weights we put on those asset classes in your portfolio. It’s important to match up the portfolio, what you’re comfortable with, and the rate of return. If those aren’t syncing up, if those just aren’t possible, then we’ve got some tradeoffs and some decisions that need to be made. And of course, those are your decisions to make, but as Financial Planners, our job is to help guide you through that process.
The number two thing that can go wrong is if you get tempted to make one of the greatest investment mistakes, which is getting caught in the fear and greed cycle. Remember the quote from Warren Buffett about how we want to be greedy when others are fearful and fearful when others are greedy? But I can tell you from experience and all kinds of research studies, that the average investor does exactly the opposite because they get caught in an emotional fear and greed cycle, which causes them to do the exact opposite of what they should be doing. They buy high and sell low. As you’re listening to this and as I’m saying it, that sounds insane. Why would anybody want to do that? Because of panic and extreme fear on the downside. In other words, when the market is falling and businesses are shutting down and there’s no end in sight as far as how bad the economy could get—or it’s back in 2001 after the planes hit and we saw the towers fall and wondered, “How many more attacks are we going to see here? All the airlines are shut down.”
How scary was that day? Back on September 11th, we didn’t know what was going to happen for quite some time, and really, I think there was a lot of fear that this was going to get much worse before it got better. Thankfully, there were not a lot of other terrorist attacks following that one. Nothing on the scale anyway of what we saw then, but bottom line is there was extreme panic, fear, people wanting to sell. In fact, the stock market closed that day and didn’t open for several days because of where the attacks happened. I remember how scary that was. And when you get that scared, that panicked, who knows what you might do with a portfolio? You might make some really rash decisions.
The polar opposite of that, of course, is the greed cycle, and I think that’s where we’re at right now. People aren’t very afraid as far as the stock market, even though of course there are lots of problems out in the world and we’re bombarded about it by the news media on a day-to-day basis. During the greed part of the cycle, what people are afraid of is missing out.
I hope this isn’t you, but can you imagine getting panicked and fearful and selling out all of your portfolio back at the bottom of the pandemic bear market that in 2020 and then watching everything come back and then some? And now sitting in cash thinking, “Oh man, I don’t want to miss out anymore when the stock market keeps going up.” What you could end up doing is buying back into the market much higher than you sold just because of not wanting to miss out on those rates of return. The extreme of this is that you can get sucked into taking huge amounts of risk on things like crypto currency or stocks that have skyrocketed. It looks almost like a lottery ticket with the idea that, “If I just get this one trade right, I’ll have all the money in the world.” And of course, that doesn’t happen most of the time. There are a few people who get lucky. But ultimately, you don’t want to get caught in that fear and greed cycle.
Remember, we want to buy low and sell high. That’s the first rule of investing, right? Do we want to buy high and sell low? No, of course we don’t. But the average investor doesn’t have a plan. They don’t know their risk number and end up making bad emotional investment decisions that create a mess in their portfolio. They end up being really disappointed.
So, my call to action to you today is to find out what your risk number is, and the second part is really important as well—which is to figure out how much risk you are currently taking. If you want to look at all your investments in your portfolio and do a risk assessment, we can do that for you. We’re happy to do that for you. We’ve got great tools that will measure the risk. Even if you don’t work with us as a client, that’s fine. We’re happy to just do it as a service to you because those are really important things to look at.
Number one, what is your risk number? Number two, how much risk are you currently taking? To find out your risk number, you can just go to our website, www.keystonefinancial.com for our investment firm and get the free risk assessment. You will get some results in just a few minutes that show you what your risk number is. Then, if you want to take that second step and have us take a look at your current portfolio to make sure it matches up to your risk number, we’re happy to do so whether you’re a current client or maybe somebody who hasn’t talked to us yet.
Maybe you’re just self-directing your investments and after talking with us you say, “I’m still comfortable doing my own thing.” That’s OK. Actually, most of our clients used to self-direct their investments and then got to the point where they wanted to hire a professional. So, if you’re still self-directing, that’s perfectly fine, we’re still happy to help you. Take us up on our offer and use this as an opportunity now that times are good and the market is at a high point.
Does that mean the market can’t go higher? No. I’m not trying to scare you, not trying to say I think the stock market’s going to drop a whole bunch. I don’t know that. Who knows when that’s going to come up? But history teaches us that when times are good and prices are high, it’s a good time to at least take a look and make sure you have that clarity; that you have the optics to be able to see where you are. Are you in the right place or do you need to make some adjustments?
Now is the time to do that. Don’t wait until the market has dropped a whole bunch. At that point, you’re probably going to be making investment decisions that are just emotional, so let’s do it objectively right now using good tools to figure it out.
So I hope this has been helpful for you. And I hope you use this as an opportunity for a reset, or at least just a check-up on your current portfolio to make sure you’re where you need to be. Nobody can guarantee anything in the stock market, the bond market, the real estate market. These are all things that are not guaranteed. The only thing that’s guaranteed, as Ben Franklin said, is death and taxes. So when it comes to the investment world, it’s important to know where your risk is. Know where the risk is and what a bad year looks like.
Enjoy filling out that assessment. We look forward to talking with a lot of you about that going forward. We get to have those conversations every day with clients. But if we haven’t had that conversation with you, let’s get that started. And if there’s anything we can do to serve you better, your family, your coworkers, your friends, please let us know.
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Have a wonderful week and God bless.
This episode has been prepared for informational purposes only and is not intended to provide and should not be relied upon for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors investment advisory services offered through Keystone Financial services and SEC registered investment advice.