The Learning Centre:
How to build a balanced portfolio that reflects your risk tolerance
Do you know how much risk you’re willing to take on in order to achieve your investment goals?
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Investment experts agree that one of the most important things to consider when developing an investment strategy and a balanced portfolio is your risk tolerance. So here’s a question: Do you know how much risk you’re willing to take on in order to achieve your objectives?
You can measure your risk tolerance in financial or emotional terms.
There are two ways to measure your tolerance for risk. First, there’s the financial measurement. This should reflect your time horizon, income, liquidity, and net worth. As an education member, you should include your pension plan when considering your financial resources. Generally, the more you have of these things, the more risk you can assume, because you have a greater capacity to recoup any losses.
Why is your time horizon (the time you have before you’ll need the money you’re investing) so important?
Let’s say you have 25 to 30 years before reaching your 85 or 90 factor (and retirement). That’s a lot of time to recover from any downturns in the stock market. Historically, the market has increased over time, so you can invest more aggressively in things like stocks or equity mutual funds. If you have less time to invest (and therefore less time to recover if the market has a sustained period of decline) you’re less likely to invest aggressively.
What are the risks of investing in mutual funds?
Your income and net worth also affect your risk tolerance. “Ask yourself, if I lost 20% of my wealth this year, could I still meet my financial goals?” recommends Educators Certified Financial Planner professional, Mike Cunningham. “While nobody wants to lose 20% of their wealth, a younger investor has the benefit of time on their side. On the flip side, a higher-earning/high net worth investor that is more established in their career has excess cash flow and assets that can be rebalanced. They all may be able to withstand the loss and ultimately see a positive return in the future. An older investor, or one with minimal assets or cash flow on the other hand, should have a portfolio of more stable investments such as bonds or fixed yield investments, which are less likely to react to volatility in the stock market.”
But as anyone who’s ever lain awake at night when the market is volatile will tell you, there’s a second measure of your risk tolerance, which is the emotional component. This can cause investors to make irrational decisions, be it selling when the market has fallen, or buying when the market is at its peak. If you lose sleep worrying when the market is volatile, it could be an indication that a less aggressive portfolio (one less sensitive to the market’s ups and downs) is right for you.
Read more in our Mutual Funds 101 series.
Getting the asset allocation that reflects your risk tolerance requires professional advice.
It takes specialized education and experience to pick investments that reflect an investor’s risk tolerance and goals. Your Educators Certified Financial Planner professional can ensure that your portfolio meets all your investment needs, such as ensuring your cash flow is sufficient during the summer months and making sure you have enough pension income in retirement.
But there is more than your long-term investment strategy to consider.
Portfolios also need reallocating as well as rebalancing.
When you experience a major life change (your spouse loses their job, you have collective bargaining issues, the furnace dies), you need to ensure your portfolio is continuing to reflect your needs. This is called reallocating—which is basically the process of altering the mix of assets to be more appropriate for your new circumstances and objectives.
For example, education members nearing retirement may want to decrease the amount of higher-risk investments they hold and increase the amount of income-producing investments. This is why you and your Educators Certified Financial Planner professional should be looking at your portfolio whenever you’re inching closer to retirement or experience a major life change.
Regular rebalancing of your portfolio is important.
As a result of the normal ups and downs of the financial markets, the asset allocation within your portfolio will shift and change. This is because different assets will have different returns. If, for example, the stocks within your portfolio are growing at a faster rate than other investments, the percentage of stocks will increase and your asset allocation (or balance within your portfolio) will no longer be the same. If left unattended, your portfolio could become more aggressive than you intended.
One approach to keeping your portfolio allocation in line is to rebalance your portfolio once a year, as part of an annual financial assessment. Or, you may want to rebalance when your portfolio’s strongest asset class exceeds your target allocation by a specific percentage. Again, your Educators Certified Financial Planner professional is your ‘go-to’ source for advice to ensure your portfolio maintains a balance that’s right for you.
Did you know?
One way to easily ensure your portfolio maintains its balance is with Educators Monitored Portfolios™. Available in four different asset allocations and reflecting different levels of risk tolerance, Educators Monitored Portfolios are chosen by professional mutual fund portfolio managers—who will automatically rebalance them on a regular basis to maintain their original asset allocation. Not only is this is a real time-saver; it offers you genuine peace of mind.
If you have questions about risk tolerance or investment planning, get in touch with us today.
Having worked exclusively with education members since 1975, we understand everything from your pay grid and pension—to the unique financial challenges you face. That means we have the educator-specific insight to provide you with the expert advice you need to build and maintain a balanced investment portfolio.
The information provided is general in nature and is provided with the understanding that it may not be relied upon as, nor considered to be, the rendering of tax, legal, accounting or professional advice. Please ensure to consult your accountant and/or legal advisor for specific advice related to your circumstances. Educators Financial Group will not be held responsible or liable for any losses, costs, damages or expenses incurred by reason of reliance as a result of the aforementioned information. The information presented was obtained from sources that are believed to be reliable. However, Educators Financial Group cannot guarantee their completeness or accuracy.