Grab your coffee and fix it up ‘just how you like’. The theme for weekend reads is risk tolerance. And when we write about ‘what is your risk tolerance level’ we are referring to your comfort level for watching your portfolio go down in value. Are you comfortable watching 50% of your monies ‘disappear?’ How about a 40% drop? 30%? Perhaps you’re only comfortable watching your portfolio go down in value by 10%. It may even be possible that you have zero tolerance for risk and you need all of your assets in guaranteed investments such as cash and GICs. In retirement you may use an assortment of cash, GICs and annuities. On that front please have a read of Pensionize Your Nest Egg With Annuities, Your Super Bonds.
But hopefully you do have some tolerance for risk and that means having the ability to hold stocks that offer much greater growth potential. As you may know stocks have historically earned an average of 8, 9, 10% or more per year over longer periods, but there’s never any guarantee of returns in any period. And we never know what our future gains may be. But we take on that risk (owning that growth engine known as stocks) to build considerably greater wealth. In retirement we use those stocks to beat the snot out of inflation. Inflation is a wealth destroyer. Stocks are an inflation fighter. Inflation is created by higher prices, you want to own many companies who are participating in and perhaps profiting from those higher prices.
So what is your risk tolerance level?
The easiest and perhaps most accurate way to know your risk tolerance level is to hold an investment portfolio through a stock market correction and take note of how you feel and more importantly – what you do as you watch your portfolio decline in value. If you have not invested through a market correction you have to make a best guess; you’ll find out how well you know yourself. And perhaps put it in dollar terms. How would you feel watching your hard-earned $100,000 drop to $50,000? What decline would make you sell in fear?
And it’s impossible to know with your risk tolerance certainly. I would suggest that you err on the side of caution. We want you to have a positive investment experience through volatility, otherwise you might get scared off for good – and you’ll miss out on all of the future stock market gains. That will greatly impair your net worth and your retirement. So, you might begin with a conservative portfolio and feel your way through the next stock market correction. You might then be able to increase the risk level of your portfolio. The ‘investment game’ is a learning process.
Bonds as shock absorbers.
Investing is quite simple. We have the stocks for growth and we have those bonds that manage the risks. Stocks and bonds can be polar opposites, and that’s why they work well together. As I wrote Stocks are the unruly kids, bonds are the adult in the room.
The answer to creating a portfolio that matches your risk tolerance level is ‘how many bonds do you need?’. Well it’s not the number of individual bonds of course, but what percentage of your portfolio do you need to be in bonds?
A wonderful learning tool for volatility (portfolio drawdown) can be found on the Steadyhand site. This week I wrote a feature post on these Undexers with Most Canadian Investors want advice. Many could also use a Steadyhand. The folks at Steadyhand are all about that coaching of clients and making sure that they understand what they’re getting into. We can feel that in their name. Here’s a link to their Volatility Meter.
You can adjust the time period and that ratio of stocks to bonds. Here’s a pass where I created a very conservative portfolio of 80% bonds and 20% stocks. The adults rule and we see that there are only 3 years of negative returns from 1961 through to 2018.
The greatest drawdown for the test period was about 9%.
Have some fun. Play around. You’ll learn a ton about portfolio construction and risk.
More Weekend Reads.
I will selfishly start with my post this week on Seeking Alpha as that can offer a different shading to what is investment risk. Investors who embrace dividends might suggest that they don’t worry much, or at all about the prices of their stocks, they’re mostly keeping an eye on the dividend payments. And I had suggested that they know that those dividends are not created out of thing air with Sorry, Dividend Investors Are Not Stupid.
And of course, here’s a quick way to knock off a whole bunch of great reads and links with Weekend Reads from Mark Seek at myownadvisor. You’ll also find many interesting personal insights on Mark’s recent posts as he and his wife prepare to downsize their living arrangements and perhaps add other life simplifications.
On wonderful and simple ETF Portfolio construction please have a read of this post on Boomer and Echo – Vanguard All Equity ETF (VEQT): My New One Ticket Investment Solution.
And of course there are also many great reads on FindependenceHub. There are many recent and interesting posts covering divorce, savings accounts, behavioural economics and housing affordability. I am partial to this post on a new type of annuity.
Here’s a provocative post from The Dividend Guy, International Stocks, Do You Really Need Them?
On MoneySense Jason Heath answers Can Canadian seniors collect government benefits while still working? I sure hope so, cause I won’t be able to truly retire for quite some time. I’ll need monies coming from everywhere.
On MillionDollarJourney a guest post from Chrissy of Eat Sleep Breath FI, Financial Independence, It’s About Why Not How. Hear, hear to that one.
And on the crap that goes on out there with regularity IG settles with MFDA over suitability of DSC sales to elderly clients. IG of course is the rebranded Investors Group. That akin to Kentucky Friend Chicken changing its name to KFC when people found out that eating buckets of deep fried chicken and french fries isn’t good for you. You know what else is not good for you? paying 2.5% on your investments and being taken advantage of. Yes I ended a sentence with a preposition. I had to.
And TD and Royal bank reported very solid numbers this quarter. Of course they make a lot of monies from their wealth management fees but the foreign assets are becoming the main revenue and profit drivers. Of course Larry Bates and myself would suggest that YOU own the banks, don’t let them own you.
On the Robo front recent news from Nest Wealth with the acquisition of RazorPlan and from Wealthsimple who nets an additional $100 million in funding and announces plans for the future with mentions of mortgages and an IPO and generally taking over the investment world. We welcome the news and greater noise and awareness that is to follow.
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