Financial planning experts agree you should begin saving and investing for retirement as early as possible and take a long-range view. Many of these professionals say that young investors should plan on replacing 80 percent of their income with retirement savings.
But, it's crucial that you first assess your investing risk threshold because even employer-sponsored plans usually require you to choose among different investment options. The overarching principle about risk is that the more you assume, the greater your potential gains but also the greater your potential losses. Determining this requires honest self-appraisal. Here is a breakdown of some possible levels of risk tolerance when it comes to investing for retirement.
High level of risk tolerance
If you have a high investing risk tolerance, you're a risk taker or optimist by nature. You may be OK weighting your portfolio with lesser-proven stocks or other investments that could be on the cusp of big gains but could also dip dramatically if certain assumptions about markets and demand don't pan out.
Moderate level of risk tolerance
If you can tolerate some risk, you may prefer investments that are likely to produce solid gains over time but may also drop somewhat. Many established companies produce those types of results, which track equity markets, such as the S&P 500 or Dow Jones Industrial Average, or an industry's wider performance (real estate, for example).
Low level of risk tolerance
If you're uncomfortable with all but the smallest risk, you'll probably be more comfortable buying into more conservative products, such as blue-chip stocks, consumer goods stocks, utilities and bonds. These types of investments typically generate more moderate gains in share price but are less likely to nosedive.
What to consider when assessing your risk tolerance
When thinking about how much investment risk you want to take on, you should be practical. Your financial circumstances may justify taking some reasonable chances or ratcheting down your risk profile. You may see opportunities that merit the suspension of your usual threshold on a single-case basis or backing off an investment that might normally attract you.
If you’re not sure what your level of retirement risk tolerance is, then ask yourself the following questions:
- Do you anticipate your income over the coming years will grow considerably, or will it grow only moderately? This is difficult to predict and involves many factors, including how hard you work. But, if compensation in your profession usually heads considerably upward and you're on a good track, then you may want to raise your risk threshold.
- Do you have worries about the stock market? Stocks statistically outperform other forms of investment over time, and there are ways to invest in them that carry a low risk of big losses, including mutual and exchange-traded funds that tie to bonds, precious metals or companies from steady, albeit slow-growth, companies. That said, there are many other investment options outside of equities, and those can create big returns.
- What type of lifestyle do you want? If you want to have a big family, new cars and a large house, then you'll need to reconcile these expenditures with your retirement goals. That may require ensuring what retirement investments you make are on the more cautious side. If material items are of lesser importance, then you might consider a wider range of investments.
- At what age do you hope to retire, and what's your idea of retirement bliss? This question leads to several more specific ones. Are you looking to retire young? Do you envision staying in the same home with the same expenses you had when you were working, or would you be happy downsizing to lower your living expenses? Do you dream of traveling when you retire? Do you see yourself moving to a small town? Do you want to ensure that you have enough money to meet potential healthcare needs, including the potential hiring of an aide later in life? Your answers will help determine your perspective to certain investments and your overall retirement strategy. That includes how much money you aim to put away and how soon you'll want it available.
Risk tolerance is a highly individual matter. You should consider working with a financial advisor who can help you further shape your risk philosophy and suggest products that fit within it.