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Navigating Risk: Understanding Your Ability and Willingness to Invest

Updated: Jun 26

Brian McGeehon, CFA®, CLU®

Partner, Chief Financial Officer & Wealth Advisor

 

 

INTRODUCTION

 

Investing is not just about the numbers; it’s about understanding yourself. Two key factors to consider are one’s ability to take risks and the willingness to take risks. While both play pivotal roles in shaping your investment strategy, they cater to different aspects of your financial life. Ability is an objective measure based on financial standing, while willingness is a subjective reflection of personal comfort and experiences. This blog aims to demystify these concepts, offering insights and a self-assessment tool to help you gauge your own risk profile.

 

THE ABILITY TO TAKE RISKS: A FINANCIAL ASSESSMENT

 

Your ability to take risks is determined by your financial resilience—the capacity to absorb losses without derailing your financial independence or lifestyle. It’s influenced by several key factors:

 

·       Debt Levels: High debt can constrict your ability to weather financial storms, as obligations may necessitate the premature liquidation of investments at a loss.

·       Emergency Savings: Adequate emergency reserves provide a financial buffer, allowing you to endure investment volatility without needing to cash out investments, especially during down markets.

·       Time Horizon: The length of time until you need to access your invested funds can significantly affect your ability to take risks. A longer horizon allows more time for recovery from market downturns.

·       Insurance Protection: Proper insurance coverage (health, life, disability) shields against unforeseen financial hits, indirectly supporting a higher risk capacity.

·       Income Stability: Consistent and reliable income bolsters your ability to take on investment risks, providing regular contributions to offset potential losses.

 

ILLUSTRATING ABILITY WITH REAL-WORLD EXAMPLES

 

Consider Anna, a young professional with minimal debt, substantial emergency savings, and a long-term investment outlook. Her stable job and comprehensive insurance coverage position her with a high ability to take investment risks. In contrast, Brian, nearing retirement with significant debt and limited savings, faces a constrained ability to absorb financial volatility.

 

WILLINGNESS TO TAKE RISKS: THE PSYCHOLOGICAL DIMENSION

 

Willingness to take risks reflects your psychological comfort with the uncertainty and potential for loss in your investments. It's shaped by:

 

·       Investment Experience: Familiarity with market dynamics can temper fear, potentially increasing your risk tolerance.

·       Financial Knowledge: Understanding how markets operate can empower you to take calculated risks.

·       Personal Experiences: Past financial successes or traumas significantly influence one’s comfort with risk.

·       Risk Perception: Your view of the current economic and market conditions can sway your willingness to invest aggressively or conservatively.

 

PERSONALIZING WILLINGNESS THROUGH STORIES

 

Jennifer, an experienced investor who has weathered several market cycles, possesses a high willingness to take risks, trusting in the market's long-term growth. Conversely, Jack, who suffered significant losses in a past downturn, exhibits a cautious approach despite having a solid financial foundation.

 

FINDING YOUR EQUILIBRIUM: BALANCING ABILITY & WILLINGNESS

 

An effective investment strategy aligns your ability and willingness to take risks. Discrepancies between the two can lead to discomfort or missed opportunities. Striking a balance ensures that your investment choices resonate with both your financial reality and your personal comfort level.

 

SELF-ASSESSMENT QUESTIONNAIRE: GAUGING YOUR RISK PROFILE

 

To better understand your own risk tolerance, consider the following statements and rate your agreement on a scale of 1 (low) to 3 (high):

 

1.       My debt-to-income ratio is low, giving me financial flexibility.

2.       I have emergency savings that cover at least six months of living expenses.

3.       My need to withdraw from my investments is more than 10 years away.

4.       I have comprehensive insurance coverage to protect against significant financial losses.

5.       My income source is stable and expected to remain so.

6.       I am comfortable with the potential of losing money in the short term for the possibility of higher returns in the long term.

7.       I have experienced market downturns before and remained calm.

8.       I actively seek to expand my financial knowledge and understanding of investments.

 

SCORING RISK TOLERANCE:

 

·       Ability to Take Risks: Sum scores from questions 1-5.

·       Willingness to Take Risks: Sum scores from questions 6-8.

 

INTERPRETING YOUR SCORES:

 

·       High Ability and Willingness: You're suited for potentially higher-return, higher-risk investments.

·       High Ability but Low Willingness: Consider educating yourself on risk management to possibly become more comfortable with taking calculated risks.

·       Low Ability but High Willingness: Focus on strengthening your financial base to align your investment strategy with your risk appetite.

·       Low Ability and Willingness: Conservative investments might be more aligned with your current financial situation and risk comfort.

 

CONCLUSION

 

Understanding the distinction between your ability and willingness to take risks is crucial for crafting a personalized investment strategy. By assessing both aspects through honest self-evaluation, you can navigate the investment world with confidence, making decisions that align with both your financial objectives and personal comfort level.

 

A seasoned advisor can offer expertise, perspective, and customized solutions that cater to your unique circumstances. At Gatewood Wealth Solutions, we stand ready to assist you in understanding and striving to optimize your risk profile.

 

Our team of experienced advisors is equipped to analyze your financial situation comprehensively, taking into account both your ability and willingness to take risks. We work collaboratively with you to develop a robust investment strategy that aligns with your goals and comfort level. Whether you're seeking to maximize returns or prioritize capital preservation, we're committed to helping you seek to achieve financial success.

 

Take the first step towards a more confident financial future. Reach out to Gatewood Wealth Solutions today to schedule a consultation with one of our knowledgeable advisors. Let us guide you towards a path of confidence and prosperity in your investment journey.

  

 

 

 

 

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk including loss of principal.  No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

LPL Tracking #565065

 

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