Know Yourself Before You Invest

Most people who invest have completed a Know Your Client questionnaire designed by financial institutions to identify your investment style and assist in choosing the correct investments for your portfolio.

However, the questionnaire is too superficial to identify your actual preferences when it comes to your time horizon and risk tolerance.  The Know Your Client form is actually a “cover your butt” piece of paper designed to protect the financial institutions from liability.

Before you put any money into an investment, you need to know yourself.

Time Horizon

While investment advisors like to draw a direct correlation between your age and your time horizon, you shouldn’t.  Time horizon isn’t fixed.  As you get closer to using the money your time horizon shortens and your investment choices must change.  It’s less about how old you are and more about when you’ll need to spend the money.

When you are young you will have to make different choices depending on whether you need cash from investments in a couple of years, 5-10 years, or are saving for your retirement years.  Decide at what point you will actually need funds for a new vehicle, to purchase a house or take your dream vacation and set up your accounts accordingly.

Even if you’re 50 years old, depending on when you want to cash out, you may still have a 20-year investment horizon ahead of you.  That leaves you the flexibility to choose from both fixed income and growth investments.

Risk Tolerance

When measuring your risk tolerance you need to take in a big picture perspective.  What is your disposable income?  How much do you have invested?

If $20,000 represents your total savings you’re more likely to experience anxiety if it is all in a higher risk investment.  On the other hand, if that $20,000 represents a small portion of your overall portfolio, volatility may not be an issue for you.

Some people take on more risk than they would normally because they don’t understand that there is a risk.  Sometimes the opposite is true.  People who are very afraid may think they are taking more risk than they actually are.  What we think is true and what actually is can be quite different.

Young people are not necessarily more inclined to take risks because of their longer time horizon and older people don’t just suddenly head off to safety.  Some risk takers may have to pull back a little.  They need to allocate at least a portion of their portfolio to lower risk investments or they could lose it all.

On the other hand, the scaredy cats may have to force themselves to venture a little out of their comfort zone in order to create a more balanced investment strategy.  A lot of the time just some education on the various investment products and how they actually work can increase a person’s risk tolerance.

Know Your Client? Know Yourself

When the stock market is zooming on an upward curve, it’s easy to tell yourself that you are very risk tolerant.  It’s when it hits the downward slope that your true feelings come to the fore and an abstract question on a form is not really going to identify them.

It’s important to know everything you need to about the investments you are purchasing including the risks involved.  And most of all, it’s important to know yourself before you invest.

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  1. Mark on March 24, 2011 at 10:32 am

    I don’t like that some advisors recommend automatically switching to fixed income when you hit retirement. people are living longer and still need exposure to the market so their money isn’t eaten away by inflation over time.

    • Boomer on March 24, 2011 at 4:58 pm

      Hi Mark. I agree. As I mentioned, retirees may need their investments to last 20 or more years and should still keep some growth in their portfolios and switch portions to income as desired.

  2. Liquid on March 24, 2011 at 2:32 pm

    “Knowing yourself is the beginning of all wisdom. ” – Aristotle

    • Boomer on March 24, 2011 at 4:58 pm

      Hi Liquid: Good quote.

  3. My Own Advisor on March 25, 2011 at 4:45 pm

    Good post. This ‘knowing’ goes far beyond just financial decisions 😉

  4. Witty Artist on June 2, 2011 at 1:25 am

    Knowing yourself and establishing some purposes is the ABC of everything we want to embark upon. Knowing your strong and weak points, qualities and talents is the way to have a great journey in this life.

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