Here at Stash Wealth we are getting to be known for our controversial opinions, particularly when it comes to Millennials saving and investing. And that’s because we know that one size does not fit all when it comes to investing, budgeting is bullsh*t and doesn’t work, and that you don’t want to wait until retirement to be living your #bestlife. That’s why we always keep it real with you, and this week we are giving you the dirty truth about risk tolerance.
Risk tolerance is total BS. There, we said it. Don’t @ us. Or do, and we can keep explaining to you while risk tolerance is outdated nonsense. Or you can just keep reading and find out.
What is Risk Tolerance?
When a traditional investment advisor is attempting to assess how you would like your money invested, they often use a questionnaire to assess something they call risk tolerance. In some ways risk tolerance is as straightforward as it sounds: how much risk you are able to tolerate. However, most of us don’t really know, particularly when we are beginner investors.
In order to get a better idea of how comfy you are with risk, the advisor will often ask you about skydiving. That’s right. In order to figure out how aggressive or conservative you want to be with your investments, they ask whether you’re interested in jumping out of a plane.
And even if you prefer to never walk on the wild side, you might actually be best served by aggressive investments.
This may seem absurd, but it is super common. And it is done with good intentions. How do you figure out how much risk someone would take as an investor if they’ve never invested before? Ask them about other risky behavior! (And they can’t exactly ask you about your college partying days.)
There is always risk involved when you invest. If any financial advisor tells you differently, run away. Run far away. The higher the risk, the higher the possibility of reward, the lower the risk, the lower possibility of reward, but the lower possibility of loss, usually.
How much risk you are willing to take with your money depends on several factors, but the way risk tolerance is currently assessed is mostly BS, here’s why.
Why is Risk Tolerance BS?
What a financial advisor is really trying to figure out with their risk tolerance survey is what risks you are willing to take with your money. This should be based on when you need to use the money you are investing and how old you are. That’s it.
Just because you like to keep it risky IRL doesn’t mean you should be investing aggressively. And even if you prefer to never walk on the wild side, you might actually be best served by aggressive investments.
Here’s a real life example.
One of our writers’ parents were totally screwed over by a bad financial advisor in the late 1980s. He mismanaged their money, took risks he shouldn’t have, and left them with a huge loss on their investment. This happens. It sucks, but it happens.
Jump to the early 90s when they meet with a new financial advisor. They now have a kid, and were burned by this previous advisor. So when they are asked about their risk tolerance they say “Yeah, no, we don’t want to take much risk, keep our money as safe as possible.”
If you’re young and investing for long-term goals, you can get aggressive.
So the financial advisor puts their money in a CD or Certificate of Deposit. A few years later when they open a retirement account in their daughter’s name they also put that money in a CD. Y’all, your money is not growing if you put it in a CD. It won’t even keep up with inflation. In our recent piece about retirement savings we get into why CDs drive us so crazy, particularly for millennials.
If you are under 40, and particularly if you’re under 30, there’s a decent chance you can (and should) invest pretty aggressively for your long term goals. You have time to weather the ups and downs of the market, and the whole point of investing is to give your money the opportunity to grow. It can’t do that very effectively if you put it in a CD or other super conservative investment. Your risk tolerance has to do with the time horizon of your goal, aka when you plan to use the money.
Back to our example:
It’s 2005: Let’s say those parents invested $20k in their daughter’s Roth IRA.
Over the next ten years they invested an additional $1k/year.
Fast forward to 2015: she had about $34,000.
However, if they had invested that money in the market, even with the 2008 crash, she would have over $56,000 by 2015 based on the average rate of return over that ten year period.
That’s over $22,000 more!
KEY TAKEAWAY: Your parents’ risk tolerance has nothing to do with yours.
What Should I Consider Instead?
Time horizon of your goal. Period.
If you’re young and investing for long-term goals, you can get aggressive. Because here’s another financial reality, you shouldn’t be investing money you need right now. If you need that money in the short-term, chuck it in a high yield savings account.
Investing is for medium and long-term goals. So the further away that goal is, the more aggressively you can invest. It’s often that simple.
This is why we prefer to work with millennials, because you still have time to really get your financial sh*t together and have it pay off in a big way decades from now. And this is why we are hands-on financial advisors, because risk tolerance surveys just aren’t nuanced enough. We’re not saying you can’t DIY invest. In fact, we have a whole article on the Pros and Cons of DIY Investing. But if you decide to go the DIY route, remember what you learned here about risk, and focus on the timeline of your goals instead.