Warning Signs Your Investments Are (Needlessly) Too Risky

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Are you taking on more risk in your investment portfolio, without increasing your potential for long-term success?

Many investors unknowingly do just that and make unforced errors that cost them, either in real dollars or in opportunities to grow their net worth.

Whether it’s taking on more risk than you actually need to take, holding concentrated stock positions or relying too heavily on market returns vs focusing on what’s actually in your control to influence, these missteps can put your financial future in jeopardy.

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Watch out for these three warning signs that your investment strategy needs a course correction:

1. You invest according to your risk tolerance — but not your risk capacity

Understanding your personal comfort level with risk, aka your risk tolerance, is important. It informs how aggressively or conservatively you may want to tilt your portfolio.

Some of our clients are positioned to be much more conservative than average, whereas others are open to taking more risks. If you’re invested more aggressively, it probably means you feel more comfortable seeing unrealized losses in the short term because you’re laser-focused on the long term.

But at the end of the day, it doesn’t matter if your risk tolerance is sky-high if you don’t have the risk capacity to back it up.

Risk capacity means you have a financial foundation that allows you to lose money and stay on track to achieve your long-term goals while enjoying the life you want in the present moment.

For those who are still years away from retirement, the biggest advantage in the investment world is time. Time in the market is one of the most important factors for growing assets.

But you can lose that advantage when you take unnecessarily large risks, like betting on a single stock that loses value and never recovers or putting money into a business venture that fails. You’ve lost not just money, but all the time that passed since you first made the investment.

Part of managing a risk-adjusted portfolio is understanding what your actual goal is. You have to be able to define what “enough” savings looks like, which is the amount you need to fund your stated goals.
Going above and beyond that amount is no doubt hard to resist, but it may also be needlessly risky.

2. You’re holding on to a concentrated stock position

Holding single stocks or highly concentrated investments creates unnecessary risk within your investment portfolio. These large positions can cause dramatic swings in your overall net worth; if a stock you picked (or received because you get equity compensation from your employer) performs poorly, it can drag your overall returns down with it.

This increased exposure to more volatility could hamper your portfolio’s performance over time. Data show that from 1926 to 2024, a diversified portfolio outperformed a more concentrated one.

If you want to look shorter-term, a diversified portfolio still beats overly concentrated ones most of the time, too (and often, the concentrated portfolios trail the market).

A concentrated position isn't inherently a bad thing in a vacuum. However, it can become a problem if having that buildup in your portfolio wasn't your intention, or when it's a deviation from what your strategy and financial plan require.

When we advise our clients on dealing with concentration or single-stock investments, we recommend having a single position represent no more than 5% of your liquid net worth to keep outsized risk at bay.

Picking a few stocks that seem to be outperforming in the present moment can be tempting. But the problems here are twofold:

Outperforming stocks rarely keep outperforming over time.
It is virtually impossible to identify when to buy these stocks before they make outsized returns (so you can enjoy those gains yourself) and when to dump those same stocks before they take (so you can lock in the gain).

The bottom line: A concentration position of a single stock, or handful of stocks, in your portfolio increases volatility, decreases diversification and opens you up to the possibility of bigger losses than you can actually afford to realize.

The reason this is so particularly insidious for investors is because you likely don’t even need to take these outsized risks to achieve your goals!

Simply increasing your savings rate (or the amount of money you save annually into long-term investment vehicles like retirement plans and taxable accounts) has a far greater impact on your overall net worth growth than the investment rate of return your portfolio earns.

3. You try to rely on high investment returns to meet your goals

Imagine two households have the same income of $100,000 per year. They each see that household income grows by 5% annually. One contributes 10% of their earnings to long-term investments each year, while the other saves 25% of their income annually.

The household saving 25% of income would end up with $1.4 million over a 20-year period, assuming a modest average investment return of 6%.

The household saving less would have to earn a ridiculous 14.38% average investment return before they could catch up — which is virtually impossible to achieve over a 20-year span (especially given that the rates of return for U.S. large-cap equities over the last 10 years were 13.54%, and it’s unlikely the average investor is invested only in such an aggressive position).

So even if you lucked out and threw all your money into the one part of the market that happened to outperform over the last decade, it still wouldn't have been sufficient to make up for saving less.

You would have to take such enormous risks for even a chance at earning that kind of return … but why would you, when you could simply save more?

The bottom line: Control what you can with a good plan

You don’t have to secure massive returns (which require taking more risk!) if you just contribute more to your investment portfolio. Your own savings rate is in your power to control. The stock market is not.

Don't leave your future up to chance and luck to decide. An optimized financial strategy will help you manage downside risk while helping you leverage your opportunities.

Eric Roberge, CFP®, is the founder of Beyond Your Hammock, a Boston financial planning firm that provides wealth management strategies to high-achieving professionals. See how you can optimize your investments, reduce your tax burden and grow your wealth by requesting a free, personalized One-Page Financial Plan from BYH here.

Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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Eric Roberge, CFP®, is the founder of Beyond Your Hammock, a financial planning firm working in Boston, Massachusetts and virtually across the country. BYH specializes in helping professionals in their 30s and 40s use their money as a tool to enjoy life today while planning responsibly for tomorrow.

Eric has been named one of Investopedia's Top 100 most influential financial advisers since 2017 and is a member of Investment News' 40 Under 40 class of 2016 and Think Advisor's Luminaries class of 2021.