Investment Risk is a Balancing Act

Investors can determine the right amount of risk by considering three key factors.

It is an uncomfortable time to be an investor. Chances are your portfolio value has declined since 2008 and the idea of investment risk, the risk that your investments may lose instead of gain in value, is very clear and personal.

When we invest, we take on investment risk in exchange for the possibility of greater investment returns. Why? To avoid the other face of risk: the risk that we may not meet our financial or retirement goals simply by sticking money into a safe, but low-interest savings account. Inflation is the culprit here. Today it is 3-4 percent and most savings accounts yield only 2 percent according to bankrate.com and even less for money market accounts (.06 percent according to iMoneyNet).

It pays to understand the nature of risk, especially when discussing investing and portfolios. Balancing how much investment risk we can handle against the risk that we will not meet our financial goals is an ongoing challenge. Most do-it-yourself investors focus only on market returns, and while they are an important part of any overall retirement projection, it is impossible to control the ups and downs of the market. Let’s look at three things you can control that have a significant impact on reaching your goals: retirement income, time to retirement, and saving.

Retirement income

Only you know what your ideal retirement looks like. The question is how much money you will need to fund that retirement. As a rule of thumb, estimate that you will need about 80% of your current income to maintain your current lifestyle into retirement. But there are numerous variables. Will you travel, play golf, buy a vacation home? How often will you buy a new car? What will you budget for home repairs and maintenance? Will you have a mortgage payment when you retire? Once you have your retirement picture painted, assign a cost to each element. The easy part is answering a couple of what-if questions. What if you bought a new car every seven years instead of every five? What if you budgeted $5,000 for that trip instead of $7,000? You get the idea. Life expectancy plays a role here as well, since it addresses the question of how long your money will need to last. The goal is to have your money outlive you.

Time to retirement

Perhaps you have a retirement date in mind. But what if you were to delay retirement by a year—or maybe two? How would that affect your ability to meet your financial objective? If you run the numbers, I think you would be very surprised at what just one more year of employment—and savings—can do to get your nest egg in better shape to face retirement. Most Americans are skipping the “rocking chair” retirement. Instead, they are ramping up for a new career, doing volunteer work and making a difference in their communities. Some are even choosing to work part-time in retirement. Yes, the income is helpful, but many after-retirement choices can keep your mind sharp and your body active.

Saving

Your savings rate makes a huge difference in reaching your objectives. It is a cliché, but “Pay yourself first” is advice worth listening to. Maximize your retirement savings in every possible way. Contribute the maximum to your employer-sponsored retirement plan. Set up other accounts, like a Roth IRA and fund it. Sure, sure, there are many demands on our money. Remember that you can fund college costs with student loans, but you can’t retire on credit. Resist impulse purchases and make every big-ticket purchase a deliberate one. Small changes in saving—and spending—can have huge impact over time.

Don’t take more investment risk than you need to meet your retirement goals. But recognize that some risk is probably necessary to meet your financial goals. The key is thinking through what those needs are and adjusting where you can.  This allows you to balance the two faces of risk.

A last word on market returns, especially given the media coverage we are bombarded with each day. We have had 11 recessions and 11 recoveries since World War II…a perfect score. Every recession to date has been followed by a recovery that rebuilds wealth and confidence. While you are answering your own what-if questions, you might want to turn off the television.