The Biggest Risk in Financial Planning: Avoiding Risk
Across all generations, Americans tend to steer away from risk, and they have become even more risk-averse in the 21st century.
That spans all areas of their lives. In fact, compared with fall 2008, a new study finds:
- Just over one third (38%) of Americans are less comfortable today taking a risk with their finances
- 65% are less comfortable taking risks in their careers
- 76% prefer to live in one place, even if that means passing up opportunities to make a positive career move or increase their income.
When it comes to finances, the majority of Americans, or 79%, prefer lower risk and more stable savings and investments, according to the 2015 Northwestern Mutual Planning and Progress Study, a survey of more than 5,000 adults age 18 and older.
Avoiding Risk – Isn’t That a Good Thing?
Is avoiding risk a good thing or bad?
According to experts, one of the biggest risks in financial planning isn’t investing in a volatile portfolio, but rather avoiding risk altogether.
“Let’s talk about a huge risk: the risk of avoiding risk,” says certified financial planner Leon LaBrecque, of Troy, Michigan-based LJPR, LLC. “All too often I see clients who sit in cash, paralyzed by the next ‘big downturn.’”
The Great Recession, which lasted between late 2007 and mid-2009, undoubtedly impacted the financial well-being of many Americans, creating a paralyzing fear, which may now be preventing many from seeing any sizable returns on their investments.
While investment strategies vary for each person, financial planners say taking some risks is important in maintaining a healthy – and growing – retirement portfolio, even in the worst economic times.
Here are some things you should consider when deciding whether to take risks in your portfolio:
Your Investments: No Risk, No Return
That’s the mantra of the financial planner, says Rick Kagawa, certified financial planner and president of Huntington Beach, California-based Capital Resources and Insurance, Inc.
“Having no risk in your investments equals no returns,” he says. “If you have no returns, then you must generate all the money for whatever your goal is. This makes reaching your goal much more difficult to nearly impossible.”
The most common no-risk account is a bank account, he adds, noting that there has never been a time when you could make money in this savings vehicle. “The fact is, your money shrinks with inflation and taxes in a bank account,” he says.
You may be thinking a bank account is still safer than investing in stocks, which could plummet again and devastate your investments. But you’re wrong – for the most part.
“If you were invested in the S&P 500 for the 20-year period ending [December 31, 2014] — mind you, that includes the tech bubble, 9/11, and the Great Recession – you made north of 8% if you stayed fully invested,” LaBrecque says. “Miss the 10 best days and you halved your return. Miss the 30 best days and you made nothing.”
In other words, the solution is to have a plan and stay invested.
“The hardest thing to do with a client right after a market crash where everyone is emotionally battered [is to say] that’s when you add risk,” says Michael Black, certified financial planner and owner of Scottsdale, Arizona-based Michael Phillips Black Wealth Management. “That’s when the buying opportunities are.”
The worst thing you could do is let fear determine where and what you invest.
“I think a huge risk is fear, and history tells us that fear itself is what we really need to fear,” LaBrecque says.
Taking Calculated and Balanced Risks is Key
Of course, you shouldn’t dump all your money into stocks and see how it plays out. Instead, invest in a well-diversified portfolio and take calculated risks.
Roughly one-fifth (21%) of survey respondents in the Northwestern Mutual Planning and Progress Study said they prefer taking calculated risks in the pursuit of higher returns.
But these risks should also be balanced with certain “less risky” investment vehicles. Deciding which vehicles to invest in depends on when you will need your money, says Scot Hanson, certified financial planner at Shoreview, Minnesota-based EFS Advisors.
“For long-term money, go with higher risk, higher reward mutual funds and try to put those in your Roth IRA,” he says. “For money that you will need fairly soon, do not [take] a risk. Keep this in cash, CDs [certificate of deposit], or a low-duration government bond. You will not make much, but you will not lose much either. And make sure you do not put too much in this pot of money.”
The key is to take some risks, but also put some money aside in “safer” investment vehicles.
When Not Taking Risks Makes Financial Sense
As a general rule, start reducing market risk at around age 55, depending on when you will retire. Do this by using managed accounts in which the goal is to avoid high draw-down, Black says.
“Once you go into distribution mode, avoiding large market moves is critically important,” he says. “When you’re retired, the avoidance of draw-down is more important than achieving appropriate returns.”
It’s not surprising then that baby boomers (age 51 to 69) are considerably more risk-averse than Generation X (age 34 to 54) and millennials (age 18 to 34).
In fact, 83% of baby boomers are more comfortable reducing risk to ensure the safety and stability of their savings, even if it means lower potential for returns, the Northwestern Mutual study finds.
In comparison, 74% of Gen Xers feel the same and 71% of millennials feel the same.
Just as sentiments vary among the different age groups, financial planning solutions should be tailored to each individual.
Using a retirement calculator can be a good place to start to help you assess the right amount of risk. You might also search for a financial planner today who can help you sort out the risks worth taking – and those worth avoiding – when it comes to your future in retirement.