Understanding Your Willingness and Ability to Take Risks

April 3, 2023

In Sinatra’s classic pseudo-limerick, “Love and Marriage” he sings, “Love and marriage, Love and Marriage, Go together like a horse and carriage. This I tell you, brother, you can't have one without the other.” Maybe you can in 2023, but you definitely cannot have a sound investment strategy without a solid financial plan.

When choosing investments, savvy investors evaluate both their willingness AND ability to take risks. While an investor’s willingness to take risks is as much a personality trait as introversion and extroversion, an investor’s ability to take risks is a cold, calculated function of the expected time horizon for the investment. For example, is the investment meant to fund a child’s college education expense that starts in 3 years, or is it meant to grow wealth to fund a retirement that’s 20+ years away? Maybe it’s a mix of both short- and long-term goals, where you are deep in retirement, taking large RMDs from your IRA to fund your living expenses, but also investing a portion of the account to fund RMDs that are 10 years away. No matter what, prudent investors define their investment horizon before investing as part of a solid financial plan.

Why is this important? Some investors may have enjoyed years of double-digit returns in the stock market through 2021, only to be disappointed that their account was down 20% in 2022, right when they needed the money for tuition, the RMD, or to fund their life after being laid off. A fiduciary financial advisor can help clients avoid these major pitfalls.

Similarly, all solid financial plans involve some form of investment, no matter how risk-tolerant or risk-averse the client is. Piling money under the mattress or sheltering it in bank accounts has never been a winning long-term strategy.

Sinatra said it best, “Try, try, try to separate them, it's an illusion. Try, try, try and you will only come to this conclusion….You can’t have one without the other!”

Tune in next month when we’ll talk more about an investor’s willingness to take risks!

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