There is one big flaw in the traditional thinking about how to determine an investor’s “risk tolerance.” Traditionally, risk tolerance was thought of in terms of a spectrum moving from very conservative at one end to very aggressive at the other. And, risk was defined as how much of a loss an investor could stomach. That makes sense, but it’s only one part of the risk tolerance story.

Investors essentially have two types of risk tolerance:

(1)  Financial risk tolerance – which is an investor’s financial ability to withstand a decline in their portfolio.

(2)  Emotional risk tolerance – which is an investor’s emotional ability to withstand a decline in their portfolio.

Source: The Charles Schwab Corporation

Now, here’s the key – there could be a very large gap between these two levels. For example, some investors may be able to financially withstand a 30 percent decline in their portfolio without it negatively impacting their ability to meet their long-term goals and objectives. However, some of those same investors may be able to withstand only a 20 percent decline in their portfolio from an emotional standpoint.

The emotional risk tolerance level is effectively your “sleep” level. It’s the level where if your portfolio went down any further, it would affect your ability to sleep soundly at night.

But, there’s more…

We also have one other factor to consider here and that’s your time horizon. If you are 10 years away from needing to tap your investment portfolio, then a decline in your portfolio today should not be a cause for alarm. Why? Because you have 10 years to recoup the decline. Remember, today’s stock market prices are only relevant to those who are selling today.

As your advisor, it’s important for us to know your financial risk tolerance level and your emotional risk tolerance level. With this knowledge, we do our best to manage your portfolio in such a way that we won’t breech either of those levels. After all, we appreciate a good night’s sleep, too!

Weekly Focus – How to Sleep Better

Are you one of the lucky 42 percent of Americans who consider themselves “great sleepers?” If not, try these tips from the National Sleep Foundation:

  • Set and stick to a sleep schedule by going to bed and waking up at the same times each day.
  • Exercise regularly, but do it in the morning or afternoon.
  • Establish a relaxing bedtime routine such as reading a book or listening to soothing music.
  • When you go to sleep, make sure your room is dark, quiet, and cool.
  • Avoid caffeinated beverages, chocolate, tobacco, or large meals right before bedtime.

Best regards,

Jonathan K. DeYoe

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