Should Your Risk Tolerance Change with Your Level of Wealth?
Basically, accumulated wealth should have nothing to do with your risk tolerance, or risk management. There are two ways to look at this:
- Your risk tolerance should decrease as you get older, because you have fewer years until retirement to ride out any bad markets or bad decisions. If you’re in your 20s, you probably should be investing in mostly stocks, which over the long-term have better returns, though from time-to-time bonds can offer very good returns. If you’re in your 60s, you should be in “safer” asset classes, such as bonds and money markets. I’m 67 and I have 25 percent in stocks, 10 percent in bonds (I believe bonds are in a bubble and the face value will go down in the next few years), and the rest in money markets. I’m kind of waiting to see what the market does, as it seems to not have much direction right now. (The S&P 500 is essentially unchanged over the last 12 months. Below is a chart of the SPY ETF, which tracks the index. Each candle is 1 week.)
- Your risk management plan should never change. One thing a lot of novice investors do not do is have a risk management plan before they make a purchase. My rules are that I never risk more than 1% of my portfolio on any one investment. This doesn’t mean I spread my investments out over 100 investments. For example, if I’m thinking of buying XYZ stock (or an ETF) at $50 a share, and 1% percent of my portfolio is $1,000, I will calculate my position size based on this, as well as a stop-loss to automate the process. If I believe I need to have a stop-loss at $45 to allow the stock room to wiggle (as I call it), then my initial position size will be 1000 / 5 = 200 shares. In other words, if the stock goes down by $5, my maximum loss will be $1,000. I never hold onto a stock with a dream and hope. I can always re-evaluate and re-invest. If the stock starts to go up in price I could add to my position as appropriate, as well as raising the stop. Successful investors always do the math before making an investment. So, always do the math,
Note: I do this technical analysis after I’ve examined fundamentals. The health of the economy and the health of the company.x