One of the most common questions advisors are asked is “How should I be invested?” and unfortunately, there isn’t a simple answer. Determining asset allocation is not a “one-size fits all” process nor should it be based solely on your age or income. While it may be easy to pick a balanced, middle of the road portfolio, does that actually help solve for your goals?
Let’s start with the three types of risk: risk capacity, risk appetite, and risk tolerance. Risk capacity is your ability to take risk. Risk appetite is your need to take risk which is related to the amount of return you need. Then there is risk tolerance, which is your willingness to take risk.
For instance, think of a young professional who has quite a bit of time before they plan to retire. Therefore, they have the ability to take on large amounts of risk due to their long time horizon, and probably need to in order to achieve a sufficient return, but does that also mean they’re willing?
If we associate age and time until retirement with a person’s risk tolerance, we may be setting them up for failure in the event of market volatility. Moreover, if they can’t handle market swings, they are more likely to get out of the market altogether rather than reevaluate their risk tolerance. As advisors, we want to find the sweet spot between all three risk components.
Finally, we have reward. Most are probably aware the more risk you take, the higher possible reward you earn; but chasing reward alone is dangerous and ignores risk all together. The opposite can be dangerous as well. Most of us cannot afford to take on zero risk (all cash) and earn little to no reward while still funding our long-term goals; we must strike a balance between risk and reward.
So how can an advisor help you? By aligning all three risk components, to ensure you’re taking on an appropriate amount of risk to meet to your goals. Goal-based planning shifts the focus away from chasing returns, rather its purpose is to help you plan well for your goals and prepare for life’s many transitions. The Trust Company of Tennessee can help you with that, and your investment allocation should only be a piece of the puzzle not the star of the show.