Imagine a day when one of your stock investments falls 35 percent in a matter of minutes. If you think that’s unlikely or impossible, just consider what happened on August 24, 2015, when some exchange-traded funds (ETFs) declined at least that much just after the opening bell of trading.
What would your reaction be if you owned one of these ETFs in your portfolio? Would you…
- Sell and move into a money market fund?
- Stay cool and hold on to your investment?
- Take the opportunity to buy more shares at a discounted price?
There’s no right answer to this question. But how you answer says a lot about the type of investor you are. For example, if you answered….
- You are mostly conservative. You tend to be cautious when making investment decisions, with a wary eye cast toward market risk. An ideal portfolio strategy for you would likely favor investments that don’t fluctuate much in value over the short term.
- You are mostly moderate. You prefer a thoughtful and methodical approach to investing, giving careful consideration to your options. You are a master of your emotions and are able to stick with a strategy with discipline.
- You are mostly aggressive. You see opportunity not peril in the financial markets, and are comfortable with additional risk in order to take advantage of these opportunities. Trading in and out of your investments doesn’t bother you.
These categories are a good place to start when you’re defining your investor profile. But these definitions are too broad to be useful. As you can expect, people are more complicated than these three simple categories. Yet, many self-guided tools for investor profiling don’t go much deeper than this in helping individual investors choose a strategy that fits their goals.
If you’re going it alone with your investment portfolio, these tools can help you determine your risk profile and find an appropriate investment strategy. But you should understand their limitations. They are designed to be simple, quick and uncomplicated, so that just about anybody can use the tool to build an investment portfolio on their own. In the trade-off for being simple and quick, these tools gloss over the nuances that make individual investors unique.
This is where a financial advisor brings value. One of the benefits a financial advisor can bring to your financial life is the ability to fine-tune and personalize an investment strategy for your goals and your true tolerance for risk.
Measuring your risk tolerance not just about your comfort level with losses. The truth is, no one is comfortable with losses. Even the most aggressive investors would be distraught to experience a 35 percent loss on an investment in one day. A good financial advisor will not just talk about your comfort level with risk, but also how willing you are to take risks with your investment capital.