Could Risk Tolerance be my Downfall?

When it comes to investing for retirement, many people believe that their risk comfort level or tolerance is the most important factor to consider. However, this is a common misconception that can lead to disastrous consequences. In this post, I will explain why relying solely on your risk tolerance can mislead you in retirement planning and what other factors you should consider as in coordination with comfort level.

Don’t worry I’m not about to tell you taking more risk is a must……but I sure hope you are working with someone who you trust will tell you if your current risk level means you need to tamper your goals.

First, let’s define what risk comfort level means. It is the amount of risk you are willing to take with your money and how you feel about the ups and downs of the market. Many financial advisors use risk tolerance to help you choose an appropriate asset allocation for your portfolio. This is the mix of stocks, bonds, and other investments that matches your risk tolerance and return expectations.

While risk comfort level is an important factor to consider, it is not enough to ensure a successful retirement. Here are some reasons why:

• Risk comfort level is subjective and may not reflect reality. Your risk tolerance may be influenced by your emotions, biases, or recent market events. You may overestimate or underestimate your ability to handle risk. For example, you may feel more confident and aggressive when the market is doing well, but more nervous and conservative when the market is doing poorly. This can lead you to make irrational decisions that hurt your long-term returns.
• Risk comfort level does not consider your income needs and spending habits now or in retirement. You may have a high risk tolerance but a low income need, or vice versa. For example, you may be comfortable with a 60% stock and 40% bond portfolio, but you may need more income than that portfolio can provide. Or, you may be comfortable with a 40% stock and 60% bond portfolio, but you may spend more than that portfolio can sustain.
• Risk comfort level does not account for inflation and taxes. Your risk tolerance may not account for the impact of inflation and taxes on your retirement income. Inflation is the increase in the cost of living over time. Taxes are the amount of money you pay to the government on your income and withdrawals. Both inflation and taxes can reduce your purchasing power and erode your savings. For example, you may be comfortable with a 4% withdrawal rate from your portfolio, but that may not be enough to cover your expenses after inflation and taxes.
• Your risk comfort level may not adapt to changing circumstances in your life or in the market. You may face unexpected events or challenges that affect your retirement goals or plans. For example, you may live longer than expected, face a health crisis, lose a spouse, or experience a market crash. These events may require you to adjust your risk tolerance and asset allocation accordingly.

That’s why it’s important to consider other factors in retirement planning. For example, let’s take John, a 65-year-old retiree who had invested his entire life savings in low-risk bonds and CDs because he was afraid of losing money in the stock market. He had a risk comfort level of 2 out of 10 and believed that he could not handle any more risk than that.

John had retired with a nest egg of $500,000 and planned to withdraw 4% of his portfolio every year to cover his living expenses. He thought that this was a safe withdrawal rate that would allow him to maintain his standard of living without touching his principal.

However, John did not consider the impact of inflation and taxes on his retirement income. He did not realize that his purchasing power would decrease over time as the cost of living increased. He also did not realize that his withdrawals would be taxed as ordinary income, reducing his net income even further.

As a result, John’s retirement income was not enough to cover his expenses after inflation and taxes. He had to dip into his principal to make ends meet, which reduced his portfolio value and his future income. He also had to sell the home he raised his children in to pay for his medical bills and long-term care.

This is a cautionary tale of how relying solely on your risk tolerance can mislead you in retirement planning. It is important to consider risk tolerance in coordination with other factors such as your retirement goals, time horizon, income needs, expenses, and contingency plans. By doing so, you can create a comprehensive and personalized retirement plan that balances your risk tolerance with your retirement reality.

To be clear, it’s important to note that increasing risk does not have to be the only answer. However, not exploring the potential outcomes that can result from not adjusting goals to meet your risk level and/or savings rate has the potential to be catastrophic.

At LaCour Wealth Management, we understand the importance of taking a holistic approach to retirement planning. We believe that retirement planning is not a one-size-fits-all approach and that every client deserves a personalized plan that meets their unique needs. Our experienced team understands the stewardship required to prudently invest significant assets. As your partner, we craft strategies using our experience and prudent management approach. We offer comprehensive planning that encompasses an in-depth review and analysis of all aspects of your financial life – to help you see the big picture and enable us to personalize a plan for addressing every detail.

This blog post was created with the help of Bing Chat Enterprise, an AI-powered chatbot developed by Microsoft.

The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of LaCour Wealth Management and not necessarily those of Raymond James.

Raymond James is not affiliated with and does not endorse the opinions or services of Bing Chat Enterprise or Microsoft.

Please note that this blog post is for informational purposes only and is not intended as investment advice. Every investor’s situation is unique, and you should consider your investment goals, risk tolerance and time horizon before making any investment. Investing involves risk and you may incur a profit or loss regardless of strategy selected, including asset allocation and diversification. Prior to making an investment decision, please consult with your financial advisor about your individual situation.