Volatile times in the market can be a cause of concern and questions for investors. But if market slides are causing a rise in your blood pressure and a decline in your sleep, it may be time to reassess what kind of investor you are. One important step for any investor is to find their comfort zone. That way, when the market enters an unstable time, you can rest easy knowing you have planned your investments to match your attitude toward the market.
To find your comfort zone, there are two important terms to know: risk tolerance and asset allocation. Having an understanding of these two investing concepts can go a long ways in determining what kind of investor you.
Some people are more comfortable with risk than other people. Personalities are different, and there is nothing fundamentally better about being a risk-taker or a risk-avoider. Risk tolerance is a financial industry measure. It refers to an investor’s willingness to take risks and ability to stomach losses.
A high-risk tolerance means an investor is potentially aggressive with their investment choices, and could find satisfaction in taking higher levels of risk in exchange for the possibility of higher rewards. It also means the investor can tolerate larger losses, believing that there might be larger gains later.
A low-risk tolerance means an investor is potentially conservative with their investment choices, and could take comfort in preserving principal, knowing that lower-risk investments could mean lower returns.
Within an employer-sponsored plan like a 401(k) mutual funds are among the most common investment options available.
The financial industry breaks mutual funds into large categories – called asset classes. Some of the most common asset classes are explained in the graph below. Asset allocation refers to the way an individual investor divides money between these asset classes – and between other non-mutual fund investment options if applicable.
The most conservative investments have historically been insured or guaranteed by the United States government. An example is a Treasury bill or bond. Traditionally, small/mid-company funds and international funds are more aggressive and volatile. This chart briefly describes and ranks the level of risk and volatility of several of the most commonly available assets classes in employer-sponsored retirement plans.
Asset allocation can differ greatly depending on your risk tolerance. It is important that you take the time to understand what kind of investor you are and where your comfort zone lies. Once you have done that, you should be able to rest easy the next time the market decides to take a roller coaster ride.
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Senior Investment Adviser