How Investors Got a Handle on Risk

Among the most difficult challenges investors face is dealing with risk. As humans, we are hard-wired to steer clear of dangerous situations. Yet, in investing, we often must ignore, or at least manage, this impulse in order to achieve success. And while there's no guarantee that things will work out in our favor, history shows that stocks tend to be one of the best long-term investments around.

It can take many years for investors to become comfortable with risk and learn to manage it, and major market shakeups such as the 2008 financial crisis often serve as valuable, lifelong lessons. For some investors, the lesson was that they had more risk in their portfolios than they could handle; for others, it was that such events present rare opportunities to buy stocks on the cheap.

All this week on Morningstar.com, we'll be examining the subject of risk and how to manage it. To kick off Risk Management Week, we asked Morningstar.com readers to discuss how their attitudes toward risk have changed over time. Some said that, as they've aged, their risk tolerance has actually increased due to a greater understanding of risk. Others said they've slowly ratcheted down the risk in their portfolios rather than experience another market shock similar to 2008.

Below is a selection of reader comments, and you'll find the full discussion here. 

'Risk Is Mostly Experienced Short Term'
Many readers said that learning to handle risk is a matter of gaining perspective on it.

"I have learned that risk is mostly experienced short term," wrote hoodee. "If you can wait long enough, markets usually turn around. The one meaningful long-term risk I experience is inflation, but even that is manageable with the right mix of investments. Short-term risk or volatility is actually a buying opportunity. Over time, I have come to welcome volatility and to ride the roller coaster. When I had less experience, it was quite scary."

Seaside1, too, said that experience has allowed him or her to better assess risk.

"When I was younger, I was 100% into equities. However, after managing my parents' portfolio for over 10 years before they both passed away, I fully grasped the concept of diversification of assets," the commenter wrote. "After navigating my parents' portfolio through the past economic turmoil, I found that a 50/50 [stock-bond] mix worked very well. It provided growth without undue risk for their retirement. [By the time] my parents passed away, they were not only not harmed by the economic turmoil, they were wealthier than before it began. I have since retired and plan on maintaining a similar balance mix for my retirement portfolio."

"I have been investing since the 1970s and am now in early retirement," said ridg0008. "Have never been a real aggressive investor. Did relatively well during the dot-com bust, as I could see it coming. Also did relatively OK in this last big recession as I didn't panic and kept investing into it. But the risks that have really worried me of late have been the ways the national and global financial systems have been manipulated and under-regulated. There has been so much misrepresentation at even the corporate level that guards we used to be able to count on are not necessarily in place or operational now. And our political gridlock is heightening that risk."

Even younger investors said that time had taught them some valuable lessons.

"It's been over 12 years since I started investing," said w004dal. "Back then, at 21, I was much more risk-averse and dealt with financial risk with diversified asset allocation based on the appropriate time horizon. And now, a wife, some number of bumpy market cycles, and two kids later, I look at it completely differently. I seek adequate but not extraordinary market returns (around 6-7% annualized) to meet my goals, so I don't find myself in as many situations where I have to worry as much. I control the things I can (savings rate, being prepared for a financial emergency, sticking to a budget, investing in my career) and try to mitigate, but not obsess, over those I can't."

'I Have Learned That I Can Tolerate More Risk'
Some senior readers noted that they've actually become more tolerant of risk as they've gotten older.

"When I was younger, I tended to invest conservatively, in retrospect," wrote Bbecker7686. "I didn't have much capital and didn't have any investing experience. The thought of losing money was difficult. Now that I'm older, closer to retirement, more experienced and more knowledgeable as an investor, and have accumulated more savings/investments, I have learned that I can tolerate more risk. When my net worth declined almost 50% in 2008 I thought I might never be able to retire. ... Somewhere during that time frame I read some remarks by Warren Buffett describing that time period as 'a once in a lifetime opportunity.' I began shifting my allocation highly towards equities, such that today my asset allocation is about 80% equities/20% bonds, a strategy which has paid off very well."

Aeowyn shared a similar experience.

"I've actually become more and more pro-market risk as I age because I have the experience behind me that leads me to believe I'll be properly compensated for that risk," Aeowyn wrote. "I've also experienced a couple down markets that have shown me that I have an inclination to put money into the market during a downturn rather than take it out. So I'm not concerned that I'll jump off the roller coaster at the bottom."

But not all readers said they've grown more tolerant of risk. Some talked about losing their appetite for risk as they've aged. Hobocon was one of them, although it sounds as though he or she hasn't completely closed the door on risk-taking.

"I was very comfortable with 100% equities until I was age 55," Hobocon wrote. "Now I am age 60 and I am 60% cash and bonds and 40% equities. I am still working but will retire in two years. I have a lot of dry powder for the next market correction. If you figure out when that is please e-mail me."

Then, there was Jimoak, who described how he manages risk these days.

"When I was young I think I was more fool-hardy than risky in my investment style," the commenter wrote. "As I approach retirement my approach is to have an adequate liquid resource for five years of living expenses with the rest of my portfolio in about 90% stocks. I need to know that my worst-case scenario is covered--thus five years liquid living expense. After that risk is addressed, I believe I can take more risk with the remainder of the investments."

'I Learned a Lot From the Tech Bubble'
Several readers mentioned living through market shocks and the impact it had on their view of investment risk. For some, the bursting of the dot-com bubble was a defining moment.

"After the 2000 crash and massive personal loss in dot-com companies I do not invest in individual companies anymore. Feel 'safer' in ETFs and indexed mutual funds," wrote empathy.

"I learned a lot from the tech bubble in the 1990s," wrote Retire55. "I had several stocks that increased four to five times in value ( Cisco Systems (CSCO),  EMC ) and all was good. Unfortunately, I did not sell until it was too late. In hindsight, I have learned to take profits and diversify more. ... I still believe that stocks are the only way to get wealthy in the long run, a la Jeremy Siegel. I now think about where I want to be in 5 to 10 years and don't worry about weekly or monthly volatility."

In some cases, risk can take forms that are completely unexpected. Saabdued wrote about his own experiences with different types of risk.

"I contributed to a 457 retirement plan for many years with 100% invested in aggressive and risky stock mutual funds," hewrote. "I did very well for many years, mostly because I was lucky and stupid, not because I knew what I was doing. We suffered dearly in 2008 but continued to invest regularly, even maxing out yearly contributions to the plan. As many people had done who did not panic, I did not move a penny from the aggressive investment choices to safer havens and recovered better than I ever could have anticipated. I knew I had several more years of working so I felt I could make at least some of it back. Then I became disabled and had to retire at age 63. Realizing then that ... I could not recover again from a big loss, we went to a 70% equities/30% fixed-income allocation. I figured I could stomach that as my wife would still be working and investing in her retirement plan for several years. All went well until the recent and thankfully short-lived 7-8% market drop and I realized that I no longer had the stomach for this as when I was still working. Fortunately the market recovered and we lost nothing, but my wife and I recently rebalanced and are now at about 50/50 for our entire portfolio." 

'I Like to Think of It As Being Self-Aware'
For at least one reader, dealing with risk is about looking inward.

Treasur2 explained that his or her view of risk was changed "by my realization that I need to be aware of my own emotions regarding my thought process, being cognizant of one's self in relation to current events. That the event of the day, week, month, quarter, etc. has happened before many times and what would have been 'the smart thing to do' doesn't really ever change. ... I like to think of it as being self-aware."

Finally, frankiethepunk discussed how risk can be found in any aspect of investing.

"As the question implies, there is no such thing as zero risk," he wrote. "... Investors, if they are to be successful, must understand that a portfolio--whether it is filled with Treasury bills and bonds or every manner of equity--is a portfolio of risks. ... For example, in today's investment climate the classic balanced portfolio comprised of, say, 50% bonds and 50% equities can quite easily carry more risk than a portfolio comprised of 65%-70% equities and 30% cash. With interest rates at the very bottom of the interest-rate cycle, bonds--especially long bonds with a high duration--carry significant risk. Even cash carries risk. So I think it's imperative that investors understand that each component of one's portfolio carries its own risk profile and that it is important to understand how those bundles of risk interact with each other and can be combined to create the most favorable risk profile given the available information."

Comments have been edited for clarity and brevity.