How scared should you get?

Many people I’ve talked with confuse the term risk with the term volatility.

Risk refers to YOU.

Volatility refers to your portfolio.

 

Let’s go trail riding. Which trail is riskier to YOU if you fall down?

 

Edge

Both trails wind their way from here to there. How wiggly the trail is represents volatility in my metaphor. A straight path is harder to ride off of. A wigglier path is easier to ride off of. The steepness of the terrain around you also influences you. One terrain steepness is scarier than the other. But even the scariest path to some doesn’t bother others. So, trying to copy others with their portfolio allocation may be putting you on a steep path that really would scare you (and you realize this when you get your statement that scares you)!

 

 

Your risk is represented here by your confidence in yourself that you won’t fall. The less confident you are about falling or not, the less risky (steep terrain on the sides) the trail you should be on. Falling in my metaphor here means wanting to get off the trail and go back … in other words, leave your portfolio and running back to the safety of cash. When you do that, you don’t get to your destination.

Risk = YOU. What ability do you have to experience a loss of money? In my metaphor … how confident are you that you won’t lose your balance? If you need a specified sum of money soon that means you do not have the capacity to take a lot of risk so you don’t lose it. The terrain should not be steep should you lose your balance. If you have a better balance, then you can tolerate a steeper terrain.

Volatility = portfolio.  If you don’t need money soon, then you can let the terrain get steeper. Flatter terrain may be short term bonds. Steeper terrain may be globally diversified index stock mutual funds. Mixing the two allows one to regulate how steep the terrain may get.

Moral of the story: Be sure you are on a path you are comfortable with … volatility in my metaphor is how steep is the terrain? And, can you tolerate that steepness?

Another blog about riskReturns are less important than contributions (withdrawals) …which means you should focus more on how much you save before you retire (or withdrawal once you retire).

About Larry Frank, Sr.

Larry R Frank Sr., MBA, CFP®, is an experienced financial advisor and a published author on Retirement Planning Research. Have a financial question? Click Here to Ask Larry

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