Understanding when something is risky is just as important as figuring out how profitable it will be. What would you do if you had to choose between A) climbing a rusty 8th floor balcony railing in your slippers to get a candid photo of your “chesty” next door neighbor or B) learning how to use the internet and just googling “chesty next door neighbor” (Don’t google it at work). Unfortunately, assessing investment risks is never this simple.
Increases in return = increases in risk. More often than not, the better the ROI the more risk is involved. For example, you can potentially make more money investing in sexy penny stocks than boring government bonds. On the flip-side, penny stocks are more likely to declare bankruptcy, governments rarely go bankrupt (please ignore Argentina, Iceland, etc). To simplify, equity (stocks) is associated with higher risk while fixed income (bonds) is considered to be a lower risk investment.
Should you go balls out, invest in tech stocks and become a millionaire in a few years? Or, should you diligently put money into safe bets, knowing that these will steadily fund your retirement? It depends on your personality but it also greatly depends on your age. Age determines risk tolerance. All things being equal, the younger you are the more risk you can tolerate. When you’re in your 20’s, it’s much easier to lose everything, move back into your parent’s basement and curse the stock market to hell. At 65, rebuilding your entire net-worth while wearing soiled Depends® is an adventure none of us should embark on.
It’s important to keep risk assessment in mind when choosing various investments. A useful guideline is to subtract your age from 100 to arrive at the equity portion of your portfolio. As you get older and hair migrates from your head to the rest of your body, you should shift investments from equity to fixed income. A 20 year-old should have an 80-20 mix of stocks to bonds, when they turn 45 they should aim for a 55-45 breakdown, by the time they are 100 the stock market should be the last thing on their mind.
***If you like bungee jumping, sky-diving or cliff jumping, feel free to change the above rule and subtract your age from 110.