Many people who once thought that they could handle the stock markets swings are quickly finding that they are truly a risk adverse investor. Five of the ten largest single-day drops in the Dow Jones Industrial Average since 1899 have taken place in the past three years. Many financial planners use an investor risk tolerance questionnaire to find out what types of investments to put their clients in. While all are diversified in a portfolio of stocks, bonds, mutual funds, and other assets, some investors chose to allocate more of their assets to riskier investments despite market swings in the hopes of larger returns. But, recently, we have found that investors may not have the tolerance they once did.

We Like To Think We Know Our Risk Tolerance

In the past investors stated on risk tolerance worksheets with their stockbrokers and financial planners that they could theoretically stomach a short-term severe downturn in the stock market because they were long-term investors with a long time horizon before they would need their funds. When reality struck with the 2008 recession and now with the current stock market turmoil, many investors are starting to question whether or not they can actually stand dramatic short-term losses.

Tom Fischer is a Financial Planner in Scottsdale AZ specializing in comprehensive financial planning and wealth management.

Understanding Risk Versus Reward

One of the fundamental principles of finance and the markets is the risk and reward are directly correlated. The more that you are willing to risk in terms of short-term price swings are typically rewarded with higher rates of return over the long haul. Despite the recent stock market volatility, stocks have historically returned over 8% annual for the past 100 years. Bonds have historically returned slightly less than stocks over a long time horizon because they are often backed by collateral and bond owners have rights in bankruptcy. And, investors who have chosen the safer route of money market accounts and savings accounts have paid for their risk aversion with a very low rate of return that has barely kept up with inflation of the past few years.

Consider Your Time Horizon With Respect To Risk

If you are decades away from needing your retirement funds, you should not be a risk adverse investor. You should consider these current market dips as a time when stocks, mutual funds, and other investments are on sale. This is a great buying opportunity for most asset classes. We all have a tendency to only think about how things are going currently. It is sort of a “can’t see the forest for trees” type of phenomena. But, when you consider how long you have until you need the money you are investing and take into consideration the past historical long-term market growth, you should have a better assessment of the amount of risk you may be willing to accept with respect to your investments.

Far too many investors do not know their risk tolerance, and even more think that they can stomach more risk than recent results have actually shown they can take. Knowing yourself and accurately answering any risk tolerance questionnaires presented to you by your financial planner can help to ensure that you are invested in the best types and amounts of securities for your goals and comfort level.

Tom Fischer is a Financial Planner in Scottsdale AZ specializing in comprehensive financial planning and wealth management.