Investment Primer Part 4: Risk Tolerance Driven Investment Strategies

Risk Driven Scenarios

Risk Level Example
Scenario
Investment
Goals for Scenario
Appropriate Investments and Recommendations
Little or none You need money in the near future ( <1yr) to make a major purchase, such as down payment on a home or paying cash for a car.
  • Preserve capital: Don’t lose money!
  • High Liquidity:  Turn it into Cash quickly when need
  • Diversity: Not important
  • Small Return: Take what you can get, but do not expect much
Savings Account, Bank CDs, Money Market Funds, US T-Bills.

Recommendation: Any of the above, but for CDs and T-Bills make sure you pick the best due date

Moderate You are saving for retirement.
  •  Preserve Capital: Keep long term risk down, but accept some short-term risk.
  • Some Liquidity Limitations: Accept limitations in availability such as penalties for withdrawal or transaction costs for sale withdrawal or sale.
  • Market Returns: You want to meet or exceed the long-term rates of return by the markets overall
Mutual Funds are a great investment in this scenario, and investment accounts like 401ks often allow you to choose among a variety of funds with different asset classes and objective. Each fund has diversified portfolio and you select a diverse group of funds, all reducing risk.

Recommendation:

Pick a diverse group of mutual funds with varying levels of risk. For example, spread your money across a Growth Stock Fund, High Yield Bond Fund, Real Estate Fund and an Emerging Markets fun

Moderately High You have some money that is not needed in the immediate future outside of retirement planning
  • Preserve Capital: You want your money back, but understand that you risk a loss
  • Varying Levels of Liquidity: The riskier the investment the easier you want to get out of it fast.  Liquidity limitations need to be added to the risks of the investment itself to determine total risk
  • Above Market Returns
Mutual Funds can be a good investment because you can pick ones with higher levels of risk, but still have safety in diversification.

Direct investment in stocks and bonds may be appropriate with bonds less risky than stocks.

Recommendation:

I would recommend stocks in companies that at least meet the following criteria:

  • highly rated
  • have a long history of paying dividends.
  •  Have a current dividend yield of 2% to 4%. Note:  Very high dividends could indicate issues with growth or other issues. 4% is a good target
  • Offer DRIP (Dividend Reinvestment Plans): Pick stocks where you can take advantage of the magic of compounding your results
High You have a windfall that you did not expect and can afford to lose.
  •  High return
  • Liquidity: In some cases, the lack of liquidity is part of the risk that you are willing to take. For many high-risk investments, you want high liquidity to get out before losing it all if the worst happens.
Anything can be a high-risk investment if you are heavily leveraged and use naked options and short sales

Investments that have high risk, but can high returns include:

  •  Penny Stocks and stocks of startups
  • Junk Bonds
  • Crypto currencies (might have missed this!)

Recommendations

Most people should stay away from these strategies, but if you do you must do your homework and monitor the investment closely.

Critical to success is to have an “exit strategy” and a trigger to cut your losses or cash in.

 

 

 

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