Not long ago, Carole Urias was read the riot act by a client who was shocked at seeing that his investment portfolio returned only 1.7 per cent this year.
The client was in an income fund but, with the Canadian markets essentially flat so far this year, he made a lot less than he had hoped for.
“The client was disappointed,” says Ms. Urias, a certified financial planner in Winnipeg. “He wanted me to up his returns, but he didn’t understand that he would have to increase his tolerance for risk for us to look at more options.”
Ms. Urias, who has been in the investment business for more than 30 years, is familiar with this kind of reaction. Whenever the market underwhelms, people start questioning their choices, especially if they’re fairly risk averse to begin with, she says.
While Ms. Urias’ client may have wanted a higher return, she knew that he wouldn’t be able to stomach the even greater losses he could experience if he took on more risk. Worst-case scenario? The client sells off his portfolio and he then misses out on a market rebound.
“When someone comes to me and wants out, I strongly encourage them to stay the course,” she says.
While strong reactions to market volatility may make advisors and investors uncomfortable, it’s often a sign that a person’s risk tolerance is out of whack with where it needs to be. If investors were taking on the right amount of risk, they wouldn’t worry as much about market ups and downs, Ms. Urias says.
Getting one’s risk tolerance right, though, can be challenging – it’s not just about the proportion of stocks to bonds someone owns, but it also relates to that personʼs investing time horizon, life situation and retirement goals.
Here’s what you can do to make sure youʼre taking on the right amount of risk.
Don’t chase the highest returns
It was only a few years ago that investors could get a 4-per-cent yield just by putting money into a Canadian bond portfolio, says Kathrin Forrest, a portfolio manager at Sun Life Global Investments (Canada) Inc. Last year, that dropped to below 2 per cent, as bond yields had fallen.
“You were not even covering the expected rate of inflation over the long term,” she says.
Low returns have led investors to reach for higher yields in equity and fixed income markets, says Ms. Forrest. This is pushing some people out of their comfort zone to meet their investment objectives.
While that may seem fine when markets are rising, if stocks or higher-yielding fixed income investments retreat, as we’ve seen during parts of this year, those losses could be shocking to an investor who can’t handle seeing their portfolio drop in value.
“[The return] may be much higher [with higher-risk investments], but it may also be substantially negative,” Ms. Forrest says, especially in the short-term.
Investors, she says, have to set more realistic expectations. While a 15-per-cent return is possible, it’s not the norm, and it usually requires taking on a substantial amount of risk.
Ms. Urias tells her clients that an 8-per-cent gain over the long term is more realistic. That’s about the annual return delivered by North American markets over the past 112 years, she says, though it could be much less or even a loss in the short term.
Develop a long-term plan
Determining risk tolerance relates directly to your preferences and goals. If you want to travel the world in retirement, you may need to save more, work longer or take on more risk for the chance to make more money. If you’ll be happier vacationing for a few weeks in Florida and spending the rest of the year at home, then you’ll need less money to live on and can, therefore, take less risk, Ms. Forrest says.
“What are your overall risk and return objectives?” she asks.
Having a long-term goal can also make the market’s ups and downs seem less daunting, Ms. Urias says. It’s a good idea to be in regular contact with your advisor – Ms. Urias touches base with clients at least quarterly – so if any nervous feelings do pop up, you can talk about them with a professional.
More than just stocks and bonds
Ms. Urias likes to find niche investments that come with less risk, but perform better than their peers.
She uses low-volatility funds, which are funds made up of stocks that have a relatively low risk profile. Other ways to mitigate risk include buying investment products focused on real estate or infrastructure, employing hedge fund strategies or focusing on investments that donʼt move in lockstep with the stock market.
It’s also important to reallocate funds periodically when one’s asset-allocation mix gets out of whack. That’s what Ms. Urias does when a fund has significantly outperformed. At that point, “the party is over,” she says. “Everyone is going to rush into that [investment] next.”
As well, choose an advisor who shares a similar risk profile.
“It’s good to match your risk tolerance to your advisor’s,” Ms. Urias says. That way, you won’t be pushed into an investment you’re not comfortable with.”
When you need your money is also key to determining risk profile, Ms. Forrest says. If you have a short timeline of, say, one to five years, a more conservative approach may be the way to go. But if you have more years to play with, then an aggressive strategy could be warranted, she says.
“It all goes back to the long-term plan,” adds Ms. Forrest. Before any investment, she says, “be very clear about your objectives and constraints.”
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