Operationalizing Risk Assessment Into An Asset Allocation & A DIY Investment Portfolio

This can be really simple. And should be if you are just starting out.

You have completed your risk capacity assessment. So, you know how much you can invest (as opposed to save) and a reasonable stock:bond allocation if you need the money in the intermediate-term.

You have also estimated your risk tolerance from multiple angles to come up with a stock:bond allocation. It should have enough stock (equity) exposure risk to maximize potential returns. That risk-taking is balanced against enough bonds to stabilize the volatility to a level your emotions can handle. So, you can to stick to the plan.

In The Wrong Spot?

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You cannot exceed either your risk capacity or tolerance.

If you exceed your risk capacity, then you could find yourself selling investments at a bad time to make ends meet. Spoiler, when the economy is doing poorly you may have less personal cashflow flexibility and that is also when the markets are often down. Don’t neglect building yourself an appropriate risk capacity.

If you exceed your risk tolerance, your emotional investor beast will take over and misbehave. That can cause a performance drag of 0.2-2%/yr depending on how naughty they are and how violently your portfolio volatility is poking them in the eye. If you sell at a major market bottom or chase the latest speculative craze, the losses could be much larger.

Use the more conservative stock:bond allocation to start investing. Here is an example of how that could look.

risk diy investing

If your stock allocation is limited by intermediate term (3-10 yrs) cash needs.

Money that you may need in the next 3-10 years should be invested more conservatively than your behavioural risk tolerance permits. That is illustrated in the above example of putting risk capacity and risk tolerance together.

However, when your portfolio grows enough that the intermediate need is covered, then you could increase your stock allocation moving forward. New purchases must still be within your behavioural risk tolerance. To continue on the example from above, you could invest in a 40:60 stock:bond ETF for the first $50K invested and then consider using an 80:20 stock:bond ETF for further contributions after that.

short term investing

Of course, your risk capacity changes with time. As your timeframe to needing the money shortens, your risk capacity may decrease. Your risk capacity may also improve during that time due to paying down debt and becoming more financially established. No approach is perfect and you can’t predict the future. However, this is a reasonable balance to get started, reflect periodically, and adjust as needed.

Just starting investing? Don’t make it more complicated than this.

Comfortable & have a large portfolio, there are some nuances to consider.

You may have other assets like managed investments, a pension, whole life insurance, or a business. How do these mesh your DIY investments? Go ahead and read about that now, if you are curious or it applies to you. However, do not let that paralyze you. Get invested.