By Tosha Dunn, Spring 2016 Student Intern
When you meet with a broker/adviser/planner, again, they will ask questions about what your ultimate investment goals are, and these questions may sound like jargon. Things like “risk tolerance,” “time horizon,” etc. may be a foreign language to you. However, just nodding along and trusting everything to a person who explains a product and gives you some papers is a terrible, terrible idea. Terrible.
Risk tolerance is the amount of risk that you are willing to accept when investing. Do you want to engage in speculation in a particular industry or market, meaning do you want to take the risk by investing in a shaky start-up or a company that is just issuing an IPO (an initial public offering–this is the first time that a company makes an offering of its stock to the public, generally, and the prices associated with the stock may be overvalued, quickly spike, and drop before you have the chance to sell them at a gain in the secondary market)? Right, all of that sounds scary. So you not only need to have an idea of what risks you are willing to take, but you also need to be wary of an adviser person who doesn’t fully explain the product to you because, seriously, did you know what an IPO was; do you know that most IPOs are expected to “pop?” And what is “popping” anyway? Or a “secondary market”?
What about your time horizon? Your time horizon is the time between your initial investment and when you plan to cash out the investment, so depending on the financial goal, the time horizon can be very short (you’re saving for a new car and plan to cash out in two years) or it can be long (i.e. your plans for retirement). Time horizons and risk tolerance are linked–if you have a long time horizon, you may want to pursue a more aggressive investment strategy because if you lose, you have more time to make the money back and vice versa.
You may also hear comments about “volatility,” “business cycles,” and “concentration”…and what are all of these things anyway? Simply, volatility refers to price shifts in the market; however, those shifts can be severe and seriously affect your investments without some proper attention from your adviser. This is where the word “concentration” comes into play; if you’re invested in a single stock, then you have 100% concentration in a single financial product. Stemming from that, concentration is simply the percentage amount of your investment portfolio represented by a specific stock, or within a specific industry, or within a specific market, etc. (so it roughly means what you think it does).
And 100% of your portfolio in one stock may or may not be a problem for you depending on, that’s right, your risk tolerance. You may think that oil investments in a foreign, war torn country are the ONLY investment you should be involved in, and that’s fine. Your adviser may warn you otherwise. However, you may have a portfolio of investments across different industries, and you may be concerned about the concentration of your investments in a particular industry. But that assumes that you know about concentration in a specific, rather than general, way.
Business cycles are also something akin to what you expect; they are cycles within business where business goes up and down in a somewhat predictable pattern–you know, a cycle. Right, so generally a business cycle moves in a wave pattern with highs and lows. You may be investing in a down market but with the expectation that the market is going to go back up. However, you want to consult with your adviser about your tolerance when the market seems to be really climbing–do you sell because the market cycle may be peaking and about to move downwards fast? Or do you ride the bull? Again, it’s all about your risk tolerance and your rapport with your adviser.
And if you really want some overly detailed information about business cycles, the National Bureau of Economic Research has you covered.