As much as we’d like to think otherwise, the only thing we have control over as investors is our attitude to risk.
In a way, this fact should be liberating. By recognising that markets and individual stocks have absolutely no interest in our financial security, we should be able to neatly avoid wasting a lot of our limited time and energy glued to our smartphones and tablets willing Company XYZ to get its act together and start giving us the returns we asked for.
The only potential downside to all this, however, is that misjudging our risk tolerance can prevent us from reaching our goals. Taken to the extreme, it can mean the difference between a person retiring early and spending several more years — decades, even — slogging away at a job they despise.
So, how do we know what is an acceptable amount of risk to take if we harbour the desire to quit the rat race long before most can even consider it?
Perhaps the most important point to recognise about risk tolerance is that only the person investing their hard-earned money can know what feels right. A financial adviser may be able to offer some guidance but even this will be based on information already provided by his or her client.
As a general rule, however, those wanting to retire early are clearly going to need to be comfortable with the thought of taking on more risk. A portfolio chock full of ‘safe’ assets may be less likely to keep you awake at night but it’s also very unlikely to get you to where you want to be in double-quick time. The ability to retire early is usually the result of achieving exceptional returns in one form or another.
A pre-requisite for exceptional returns is a willingness to do what most people won’t. This could involve investing in companies lower down the market spectrum or buying stocks in (temporarily) depressed sectors — something top fund manager Neil Woodford did with great success during the late 1990s.
The amount of time a person can stay invested is also a consideration. While retiring early might be the goal, having the luxury of a reasonably long investing horizon is nevertheless beneficial since it allows a person the comfort of knowing that they have plenty of time to make up for any mistakes they make (which as a fallible human being, they will).
Buying shares just before markets correct or crash isn’t such a big deal either, assuming s/he doesn’t need access to his or her capital for a while. So long as there is an emergency cash fund to cover living expenses, these events — which we can’t predict with any certainty — can be pretty much ignored.
Related to the above, a final point to appreciate is that risk appetite changes across the lifespan. The suggestion that older investors and/or those already well on their way to achieving their financial goals (such as retiring early) should consider reducing their exposure to equities with the intention of protecting the gains they’ve already made is clearly prudent. Staying fully invested and ignoring less volatile assets such as gilts and bonds is a decidedly more risky strategy since a market fall could occur at the very time access to the money is required.
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Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.