Risk tolerance and how much to set your portfolio at, is a question everyone has. No one knows the answer, and there are some general ideas out there but truth be told – it’s so personal and depends on so much, that unless you hire someone to go through the details with you, and to tease out your thoughts/needs/requirements, you won’t ever get a straight answer of: DO THIS.
Stock market is very unlikely to drop to zero
That means that all the companies have to go bankrupt at once. If you invest in the broader stock market, it means if airline stocks dip because no one can travel any more, it means that people stay more at home, and grocery or local spending goes up (takeout, etc).
Your risk tolerance is YOUR risk tolerance
Depends on a lot of factors. You have to decide on your own based on YOUR situation.
You may have other retirement plans or sources of income
My approach is I have nothing. I do not rely on inheritances, the government, on company pension plans, NOTHING. I have nothing coming to me, and everything I have is what I have saved and invested under my name.
This is not the case for everyone – you may have inheritances you know you’ll get because your parents/family are super careful, you may have a solid pension plan that pays out for the rest of your life, or whatever else. You CAN rely on these sources if you know them to be true. Or maybe you simply have the luxury of being able to ask your family for help and they will help you in a major pinch.
1. Keep an emergency fund
The thing to keep in mind, is that you are presumably in it for the long haul. This means, you have invested money that you do not IMMEDIATELY need to pay for your mortgage/rent, groceries and so on.
If you’re in it for the long haul, the minute the stock market starts to go pear-shaped, why would you sell? Historically speaking, if we look back over 100 years of the stock market, you will see ebbs and flows. You will see the stock market drop, then come back up, wash, rinse and repeat. It’s just really, a question of time. Will it come back in 3 months? 3 years? 30 years? And with that unanswerable question of “WHEN will it bounce back”, comes “WHEN do YOU need the money to live?”
In that case, if you’re just panicking because it is “omg omg omg omg omg”, then keep an emergency fund. Simple. Now how much to keep? That’s up to you. I personally have decided to do away with emergency funds because I have reached a certain level of comfort in my spending and income, that I only keep enough to buffer daily bills (about $5000).
- When you should really keep an emergency fund?
- Use your credit card as an emergency fund
- Do we really still need an emergency fund?
2. Keep a percentage (%) in cash / bonds
An alternative to the emergency fund (but adjacent, really…) is to keep a percentage of your portfolio in cash or in cash equivalents like bonds. What this means is that if you have $10,000 invested, you could put $2000 of it in cash or cash equivalents (GICs, Bonds), and when you need that money in a pinch? You have it.
Now HOW MUCH you put in cash/bonds, is the same question as how much you need as an emergency fund. It’s up to you. Some people do it by age, something like a general like:
- 90% invested, 10% in bonds or cash equivalents (this is a Warren Buffett one)
- 80% invested, 20% in bonds or cash equivalents
- 75% invested, 25% in bonds or cash equivalents
And yet others do it by an age calculation as they age and take their age as the percentage of bonds. So for instance, if you’re 40, you should be in 40% bonds or cash equivalents, and 60% in the stock market. If you’re 20, you should have 20% in bonds or cash equivalents and 80% invested.
It’s up to you. I am nearing my 40s and I am 100% invested save for my daily bill requirements but for a number of personal reasons (to be described below).
3. Invest in the total market
The concept of risk also changes when it depends on what you’re invested in. As an example if you’re 100% invested in Bitcoin, your fortunes are dictated by the whims of the market, and perhaps the random tweets of a certain Mr. Musk. One day you’re up 100%, the other day you’re down 30%. That’s a risky ride to be on.
If you want to do such risky ventures, other than the sheer fact that cryptocurrencies are a serious & concerning detriment to the environment (and very much against my personal values), where the Bitcoin network uses as much energy in one year, as the entire country of Argentina, I would limit them to very small percentages of your overall portfolio to limit risk. I wouldn’t “invest” 100% of my money into buying Chanel bags, hoping to turn a profit in 5 years by reselling them. Period. I could buy one or two bags, but it isn’t my portfolio.
Putting cryptocurrencies aside, instead, consider investing in the TOTAL stock market, in mutual funds or exchange-traded funds that track the indexes of the market. That way, if one company drops, it won’t matter, you will see other companies tick up, but you’re invested OVERALL into all the stocks or a good chunk of them, so that your fortunes are not tied to one company.
4. Have side income buffers
Now let’s consider, weathering the storm. You know, the buffer for actually needing the money, right? Because the whole point of investing all of this money, is that you will eventually need it to live on when you can no longer work.
So, what to do? You may decide to have side incomes (rentals, part-time job, extra hours), that you could easily pick up or do in a pinch that can help pay and smooth out the expenses you have to pay for. Your side incomes, are essentially, like an emergency fund and you could technically drain / sell LESS of your investments to pay for your living. Of course, along with that you could drop your spending as well to make all of it last longer.
I personally like dividends for this but they take time to build up; you need to have capital invested in stocks that consistently pay out and increase dividends over the years (also called Dividend Aristocrats, as a term), and those dividends they pay out, you can take in cash (and pay taxes on), to live with as an income.
- Why I invest in dividends
- Calculate your dividend income from your portfolio
- How much do you need to invest to get a dividend income?
5. Understand your money needs
A comfortable, MINIMUM spending lifestyle for me is about $30,000 a year. I need $30,000 net, after taxes to pay for things, and to be very comfortable (though, no vacations and only 1 semi-wild spree included). I have tracked my money for years with The Budgeting Tool, and I understand my personal money needs to pay for my spending, as evidenced in my monthly budget roundups.
Here’s a sneak peek at my spending in the past years:
I look back, and I can see I went “wild” in many years, mostly the ones I worked, and you can see I spent way more on entertainment, wardrobe and so on. If I removed those portions in my budget and scaled back proportionately, $30K is my minimum. Of course, in some years I spend more than that, like 2020, but take a look again at the pink chunk in 2020 that is Wardrobe/Entertainment. If I removed that, I am well under $30K spending a year.
6. Don’t go “all in” on risks
I feel like I said this already, but I am repeating it. If you are planning on striking it rich on one stock or one company, please do not go “all in”. Be prudent. Throw in a maximum of $5000 or $10,000, WHATEVER YOU CAN AFFORD TO LOSE, and imagine what would happen if you lost it all?
I know a guy at work, who was plowing money into this super scammy sounding “investing plan” where they were teaching investors about how to invest in cryptocurrencies. He couldn’t explain to me what they did, how they did it, what documentation they had (their courses), nor what cryptocurrency even was.
And yet. He was putting in $10,000 every 2 weeks, as much as he could, plowed in about $60K in total before I came along to shoot the breeze, and red flags and alarm bells sounded in my head. I very worriedly told him to stop investing because it seemed like a lot already, and I asked him to please be prudent. But he wouldn’t listen, he was seeing $1M payouts for his “investment”, and there’s nothing you can say at this point to people who won’t listen and are too far gone. So I am saying it here: Do not go ALL IN on risks.
Now.. for what I do, personally:
Small buffer of $5K
As mentioned before, even if I go 2-3 years without working like I did in the past, I no longer need to keep an emergency fund. I have a line of credit of $25,000 open at 3.45% at a local bank that I never use, another $10,000 in a line of credit from another bank at a shocking 8.10% interest rate. Plus I have my credit cards. And most importantly, my side incomes are decent.
Side incomes = Enough
I make enough in side incomes to cover my basic living. Last year in 2020, I made $80K. This year, I am on track for $50K. On average, I can expect $30K I think, in side incomes as a conservative estimate.
Emergency Fund is my TFSA
As a final resort (not sure where it falls on the priority list between borrowing money and my credit cards), I can dip (with trepidation and LOATHING) into my TFSA to withdraw money tax-free by selling my investments to live on it and pay my bills. I really hate selling investments, so this has to be serious.
100% invested in the market
I am 100% invested in the market, and it means:
- I still have my $5K in buffer for bills and daily spending
- I have $11K in private lending more or less
- When I am working, I get about $20K a month to replenish things – and if I lose my contract, I have enough notice to not spend or invest my last paycheque, and I can use it as my emergency fund buffer
- All the rest of my money (about $700K) is invested in individual stocks for dividend payments or in ETFs in a split
Mix of 50/50 stocks and ETFs
Speaking of splits, I have 50% of my portfolio in dividend-paying stocks (dividend aristocrats like Canadian banks), and ETFs in the broader stock market for diversification.
Risk is personal. Find out your WORST CASE SCENARIO as if you lose everything overnight, and THEN ask yourself deep questions like:
- How much can you afford to “lose” on super risky investments like cryptocurrency?
- How much do you need to live on to pay the current, immediate bills?
- How much can you get as side incomes to buffer this spending?
- How steady is your job that you can just work at it, and rebuild everything if need be?
- How long can you wait before you need the money? 5 years? 30 years?
- Do you have other retirement plans (government, company) that buffer?
My general approach is “I don’t need the money I have invested”, I have all the money I need for my interim needs through side incomes (great!), through picking up contracts, I can buffer out chunks of money at a time if needed (even better), and I keep a loose grip on my budget to not get too out of control with my spending (still workin’ on it…).
I also am extremely willful and petty. I will absolutely spend very few dollars and cut back spending to near zilch (I can reach as low as $1600 a month) if it means I keep my freedom and control over my life, even if it means I live on bread and water.
As a result, I feel confident being 100% invested. You may not be. You need to ask yourself these questions and do the exercise, plus work it into your retirement plan, etc. Only then will you know what your portfolio allocations should be.