Do You Know Your Risk Tolerance?

Some of you may not know that I taught yoga for many years, and even trained yoga practitioners to become teachers. I accidentally discovered the practice in 2011 when I joined a local gym with some friends. It turned out to be the remedy for my daily back pain caused by a car accident back in 2007.

If you’ve practiced yoga or have any other meditative routine, you know that if you stick with it long enough you start to reflect inwards. You might even learn a thing or two about why you make some of the choices that you do.

Now, I’m not writing to you today to convince you to take up yoga or meditation. But I am encouraging you to take a moment to check in with your risk tolerance. By that I mean your personal comfort level with the markets ups and downs. This self-awareness is an important piece to a successful investment strategy.

You don’t need to take my word for it. Warren Buffet, one of the most successful investors of our generation, has given us a number of quotes enforcing this:

• “The investor’s chief problem—and even his worst enemy—is likely to be himself.”

• “The stock market is a device for transferring money from the impatient to the patient.”

• “Be fearful when others are greedy, and greedy when others are fearful.”

Knowing your risk tolerance means you can act rationally instead of being driven by your emotions.

Fear Versus Greed… and Then Some

How did you react on March 9, 2020, when the S&P 500 tanked 7.6%? How about the plunges that followed on March 12, 16, and 23 before the S&P 500 finally hit its ultimate low? Were you panic selling? Were you patiently waiting for the volatility to shake out? Or were you buying all your favorite stocks at bargain prices?

Like most things, risk is a spectrum, it is not binary.

At one end, there are people who are focused on simply protecting every dollar. Some will put it in the bank via a savings account or CD. Others will keep it under the mattress so they can check on it every night before bed. The interest rate you’ll get ranges from 0% to about 4% right now. And the interest rates on savings accounts and CDs are at the mercy of the fed funds rate set by the Federal Reserve.

This is the ultimate in risk avoidance and is usually rooted in fear of losing money.

Unfortunately, this extreme lack of risk-tolerance exposes you to inflation chipping away at your principle.

At the other end of the spectrum, you have the swashbuckling risk-takers and gamblers. Being firmly planted here can cause you to become blinded by greed. Ultimately, one could easily lose all their hard-earned cash chasing the next moonshot.

The key is to own different investments along the spectrum and act with intention instead of being consumed by fear or greed. You can then adjust your strategy to fit your individual tolerance. If you’re anxious or losing sleep about your investments, you don’t have the right ones.

Build Your Base, Then Take Risk

I have developed a quick-start portfolio allocation chart that I recommend for new investors.

You want to start in the upper-right wedge and work clockwise. This means you will progress from the “safest” sector to the “riskiest,” and do so at a pace that meets your tolerance.

Consumer staples stocks are the safest slice of the pie. These companies typically sell food, cleaning supplies, and personal hygiene products whether the economy is thriving or struggling. I also include certain preferred stocks in this slice.

Preferreds almost act like a hybrid between a common share and a bond. They have fixed dividend payments and a set face value. This means your income is more stable and the share price tends to move less.

This slice of your portfolio should be big, boring businesses that will be around for decades to come. I’m talking about companies like Clorox (CLX) or Public Storage Preferred Shares Series F 5.15% (PSA-F).

Then move to oil exposure. Here you can start adapting to your risk tolerance. Pipeline companies are on the less risky side of the energy industry. These “toll roads” get paid no matter what the price of oil is… and have to legally pass on their profits to investors. You could also pick major producers or go riskier with small-cap exploration companies.

Continue through the slices and you’ll build a nicely balanced portfolio. Personally, the majority of my holdings pay at least a 4% yield. Occasionally, when I get to the Current Trends section, I’ll add a moonshot or two because my risk tolerance is high. But I’m comfortable doing that because I have already built a safe base of stocks compounding my wealth using dividend reinvestment.

I’m curious, have you ever sat down and really considered your risk tolerance? Do some of your investments keep you up at night? What specific things are you worried about in the markets right now? Let me know.

For more income, now and in the future,

Kelly Green