Personalized Investment Strategies to Match Your Risk Appetite
There is no one-size-fits-all approach to investing, but like your go-to order at your favorite restaurant, your risk appetite will tend to steer you toward the investment strategy you’re most comfortable with. Think of it like this: When we go out to eat, we select our order based on individual energy and hunger levels, health goals, finances, and more. Different investment strategies for different risk appetites follow a similar principle — just not as tasty.
Putting together the right menu to turn your risk appetite into an investment strategy might sound overwhelming. Thankfully, your local credit union has resources that can help you determine your risk appetite — conservative, aggressive, or somewhere in between — and what investment options will best suit your goals.
Understanding Risk Appetite
Let’s talk more about what risk appetite, also sometimes called risk tolerance, is. Anyone who invests should consider several factors in determining their risk appetite, including:
- Age and life stage. Younger people can generally afford to be more aggressive or “risky.” That’s because they have more time to ride out the typical peaks and valleys of the market. On the other hand, someone approaching retirement needs to limit their risk since they’ll be living off that money soon.
- Financial goals. What you want to do with your money is a significant factor in how aggressively you invest. Having more aggressive goals means you’ll need to consider more aggressive investments that also carry more risk.
- Your time horizon. When you intend to use the money also factors into your risk appetite. If your financial goals are relatively short-term, like helping build a child’s 529 account or buying a house, your investment strategy will be different than if you were focused on the long term, such as saving for retirement.
- Previous investment experience. Newer investors are often leery of very aggressive or risky investments, so keep that in mind if you’re just starting to invest. Even with experience, some people never get comfortable with risky investments — and that’s OK! There are investment options for conservative investors that can be just as successful as investment options for aggressive investors. Just because you take the slow and steady approach doesn’t mean you can’t meet your goals.
Once you’ve done a gut check on those factors and how they impact how aggressively or conservatively you want to invest, consider using a risk assessment tool. These short quizzes can help you drill deeper into your risk appetite. They’re perfect for helping you weigh some of the mental/emotional aspects of investing. Several good risk assessment tools are online, including those from Rutgers University and the University of Missouri.
Most assessment tools are short, so it’s worth checking out more than one. Comparing the results can give you food for thought and a more nuanced picture of where you stand.
Investment Options for Different Risk Profiles
As we said, everyone has a unique appetite and set of goals when it comes to investing. Still, investors generally fall into one of three categories: conservative (very low-risk tolerance), moderate, or aggressive (very high-risk tolerance). And there are generalized investment strategies for different risk appetites.
Conservative investors
If you’re a conservative investor, you’re a ‘slow and steady” type. You’ll be looking for investments that aren’t likely to drop a lot in value or have a lot of volatility or big swings in value in short periods of time.
Investment options for conservative investors include financial tools you’re probably somewhat familiar with, such as:
- Bonds and fixed-income securities
- CDs
- Money market funds
All of these options either come with safety rails like FDIC insurance or are extremely unlikely to lose value.
The major benefit of a conservative investing strategy is that you aren’t likely to lose a significant amount of money, even in really challenging economic times. However, that security comes at a cost. Conservative investments tend to have lower overall returns.
This is not the path to take if you want to retire early. In fact, returns can be so low that these investments can hurt your buying power when inflation is high. To put it plainly, your account balance might not go down, but it’s worth less in terms of what you can buy with it.
Moderate investors
Moderate investors have a Goldilocks vibe — they like things just right: Not too risky, but not overly cautious either. Investment options for moderate investors tend to be focused on choices such as:
- Diversified mutual funds
- Dividend-paying stocks
- Balanced funds
These options focus on investments that have a little more upside. Over time, they tend to return more than bonds or CDs. But they’re still relatively low risk. For instance, if you own stock in “blue chip” companies that are well established and profitable, it’s not impossible their stock will go to zero, but it’s unlikely.
The main benefit of a moderate investing strategy is that you’ll enjoy good returns during the stock market’s highs without getting killed during its lows. Your investments will grow faster than they would in conservative investments without taking on a ton of risk. The downside of the moderate approach is that the bit of extra security means you won’t absolutely maximize your returns.
Aggressive investors
Aggressive investors are the financial equivalent of people who love mega roller coasters. They’re happy to ride the extreme ups and downs to get to their final destination.
Investment options for aggressive investors tend to include:
- Growth stocks
- Real estate investment trusts (REITs)
- Alternative investments such as commodities, crypto, art collecting, etc.
Over time, these investments are more likely to bring in higher returns than the options chosen by conservative or moderate investors — the key words being over time. Because in the short term, these investments can see some sharp dips. If you aren’t prepared to watch your account balance fall by 10%, 20% or more over just a few days, the aggressive strategy is not for you. On the plus side, they can also shoot up in value quickly.
Another downside to more aggressive investments is their greater chance of losing virtually all value. If you hold stock in a tech start-up that goes belly up or the market for your commodities investment dries up, you could lose almost all the money you’ve invested. That’s the price of seeking those higher returns.
Portfolio Diversification Strategies
No matter where you land on the conservative-to-aggressive spectrum of investing, a key part of your investment strategy should include diversifying your investments for overall risk management.
It’s the modern version of “keeping all your eggs in more than one basket.” Whether you’re an aggressive investor or conservative, you want to spread your money in a few different kinds of investments. Creating a diversified portfolio by investing in different assets reduces your total risk because not all investments move in the same direction at the same time. So, if one of your investments hits a rough patch, the others may weather the times a lot better.
Once you’ve built a diversified portfolio, you’ll need to periodically rebalance it to keep it that way. Since investments grow at different rates, your portfolio can shift over time in ways you don’t want.
For example, let’s say your strategy is to keep 60% of your money in stocks and 40% in bonds. During the next few years, your stocks grow substantially while the bonds only do so-so. Before you know it, your portfolio could be 75% stocks. Rebalancing by shifting funds from one asset to another diversifies your investments and lowers your total risk.
Risk Management and Monitoring
There’s another reason you want to review and adjust your portfolio regularly. Your life isn’t static, and your financial goals aren’t either. It’s normal to need different investment strategies for different risk appetites at various stages throughout your life.
Your risk tolerance can change for a lot of reasons. For example, you might want to switch to Investment options for conservative investors because your timeline has changed or you have more (or less) money to invest. Alternatively, as investors gain experience, they often feel more comfortable with some of the Investment options for aggressive investors.
Regardless of your reasons, reviewing your investments and making changes as needed to match what you care about today is smart.
Also worth noting: Chances are you have more than one financial goal, so it makes sense to have different levels of risk tolerance at the same time. If you’re trying to build a 529 for your kid headed to college in five years, you probably want to be less aggressive with those funds than the retirement funds you won’t touch for at least 20 years.
Sound confusing? You’re not alone. Getting advice from a financial professional who can help you determine what investment strategies best fit your current goals is never a bad idea.
Further Resources on Strategies for Different Risk Appetites
Understanding risk tolerance is complex since it has a financial and an emotional side. You can learn more about both aspects here:
- See the big picture. Understand the different kinds of risk that can impact your investments so you can better determine which risks you’re comfortable with.
- Understand asset allocation. Regularly check that your accounts are diversified so you can rebalance as needed to your chosen asset allocation.
- Explore underlying impulses. Take a deeper dive into the psychology behind risk tolerance. Not only can it vary over time, but you can have high risk-tolerance in one area of your life and very low risk-tolerance in another.
Know Yourself — But Be Open to Investment Strategy Help
Having a good understanding of your risk tolerance is vital to building a successful investment strategy. While your financial future is in your hands, working with a financial professional who can help you understand your needs and craft an individualized plan can help. You can find resources at your local credit union.
