Why it doesn’t matter what your risk tolerance is

Scary hand

When investing, whether for retirement or for any longer term goals, there is often a discussion of “risk tolerance”. Risk tolerance in this context means how much variability in the investment return process that an investor is willing to withstand.

As Investopedia puts it: “if you take on too much risk, you might panic and sell at the wrong time.

Panic selling is a real problem. Because no one, not even professionals, can time the market, we often react during the most inopportune times, like selling when the market has hit bottom, or buying when the market has hit its peak. It happens, and it happens a lot.

But risk tolerance runs in the other direction too. There are those who stay entirely out of certain markets because of fear of loss. These are the proverbial “money under the mattress” people or “cookie jar” investors.

I think that’s just as dangerous.

When financial advisors and other people of influence discuss investments, they often say that the best options are all dependent on the client’s risk tolerance.

But I’m here to say that your level of risk tolerance doesn’t matter. It can’t matter. You don’t have that luxury.

Who wants to (save up to) be a millionaire?

As a rough estimate, I’d say that in order to have a full and comfortable retirement, most people need to acquire around a million dollars in their working life.

Now, I could be wildly off here. Maybe I’m off by a factor of two. Maybe you only need $500,000 to retire. (Though, just as potentially, I could be off by a factor of two in the other direction.)

Point being, there is virtually no way that you’re ever going to just save up $500,000 in your lifetime outright. Certainly not $1,000,000.

Which means that you’re going to need to put your money to work for you.

And not just by using a savings account. My Ally savings account is 1.5%. These savings accounts are risk-free, in that they are protected against loss and theft (at least up to $250,000).

But in order to get to that $500,000 mark, you would need to put away almost $1,100 each month for 30 years. That’s almost $400,000.

Going for the million? That’s $2,200 for 30 years, or almost $800,000!

Come on.

Bonds aren’t good enough either

Now let’s say that your risk tolerance is such that you’re willing to enter the market, but only for the most conservative investments, such as bonds. Now all bonds are created differently, but I’ll say that average return of a bond is around 4% (though the Vanguard Intermediate-Term Bond Index Fund has returned upward of 6% since its inception.)

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At 4%, you would need to put away a little over $700 a month for 30 years to reach $500,000. Or, for a million, almost $1,500 a month.

Now we’re approaching feasibility, but it’s still not very feasible.

The only thing we have to fear

You catch my point, I hope. I don’t care if hearing about the stock market makes you want to jump out of the window. I don’t care if investments make you actively nauseous. I don’t care if you worry that the world is going to end.

You want to know why I don’t care? Because you know what’s worse? Getting to retirement, or just that point in life where you can no longer work, and having no money.

Now, in terms of the pendulum swinging the other way, that can of course be a problem too. Those who would invest all of their retirement assets in day trading, or the latest get-rich-quick scheme, have a different risk problem. It is possible to have too much tolerance for risk.

But that’s not the biggest problem here. More people seem to have fear when it comes to investment and retirement. And I understand. The process of saving for retirement, that 20-30 years in your life where you plan to be self-funded, is scary. And overwhelming. How in the world will you get there?

I can tell you that the way you’re not going to get there is by having a low tolerance for risk. Your mattress (or cookie jar) is not going to be enough.

But enough about me. What kinds of risk are you not willing to undertake?

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