When considering risk levels, it's natural to consider risk tolerance—the appropriate portfolio risk a person would be most comfortable taking. Risk tolerance is a delicate balance between emotions and financial reality. However, the risk level of your current portfolio is an entirely different matter.
Your risk tolerance has no direct connection to the current risk exposure of your portfolio. For example, some individuals' risk tolerance suggests they need a 30/70 portfolio (30% stocks, 70% bonds) because the highest downside they could emotionally stomach in any year is 17%. Surprisingly, these same people might feel comfortable with a 100/0 portfolio (100% stocks) concentrated in just four stocks, where the highest downside in any year could be 45%—as long as the portfolio generally trends upward. This disconnect highlights a crucial point: many investors may be unaware they're sitting on an investment powder keg.
Understanding your portfolio's actual risk level, independent of your perceived risk tolerance, is essential for making informed investment decisions.
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