Psychology of Financial Planning

CHAPTER 14Financial Risk Tolerance

Gwen is 70 years old and close to retirement. As she thinks about the years ahead, she wants to receive as much income from her investments as possible while still maintaining her principal. She has a lot of traveling and activities in front of her. Her annuity, pension, and social security cover about 60% of what she is planning to spend, while the other 40% comes from a “bucket” that she fills from her portfolio. Gwen keeps several years of living expenses in that bucket in case of market downturns or other unforeseen financial issues. She remembers her older sister retiring immediately before the Great Recession and how she had to take a part‐time job to alleviate her concerns about living through her retirement. Given that Gwen is now nearing retirement, she is not an aggressive investor. She has a three‐year cushion in the event of market volatility. Ryan, her financial advisor, talks with Gwen about the historical returns of the market, stating that she has more than enough in her savings to weather any financial downturn and recommends investing a bit more. He also talks with her about what happened with her older sister a decade prior and works to develop a portfolio that alleviates her concerns and gives her confidence that she is on the right path heading into retirement.

RISK TOLERANCE

Risk tolerance is commonly defined as “the degree of variability in investment returns that an investor is willing to withstand in their financial ...