How Much Risk is Suitable for You?

There is a doctrine in law that investments must be suitable. This doctrine underlies much of the consumer protection regulation designed to prevent ‘silver-tongued salespeople’ from scamming unsophisticated investors.

You probably have heard or seen ads that promise high returns without investment risk. Indeed, this is the pipe dream of all investors: 15% per year risk-free return! When you hear a promise like this, you should see it as a big red flag. You may not know the gimmick or fine print in the deal, but your common sense says that it is too good to be true—enough said.

OK—you have made a budget and you figure out that you need $x per month to pay for your target standard of living. Let’s say that you want a $1 million nest egg to fund family-related expenses of $5,000 per month for the next 30 years. You realize two things: (1) that the cost of goods and services tend to go up in the future so you will have to adjust the $5,000 per month upwards to keep pace with inflation; and, (2) that investing means putting some or all of your money at risk. Ideally, you would like to preserve your target lifestyle by putting your nest-egg in safe one-year CDs at the bank.

You now have arrived at step two in the process of deciding how much investment risk, if any, you need to take [step one was to make a budget]. So the big question is: how much money can you spend without taking any investment risk? In this example, if you can generate a 30-year income stream with a CD that does not put your nest-egg at risk, you don’t need to own any risky investments. You may want to own some growth-oriented investments; but you don’t need to own them.

Bottom Line: You cannot take fifteen pounds out of a ten pound sack. If a “safe” investment like a CD cannot provide the funds for your critical lifestyle objectives, then that investment is not safe. It is unsuitable for you. This may be surprising because most consumer protection laws protect people from speculative or fraudulent investment schemes. However, in some situations, it is just as damaging to avoid investment risk as it is to take too much risk.

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This blog post is an adaptation of a similar post originally published on Mesothelioma Circle. Mesothelioma Circle is an organization focused on providing information and resources to victims of mesothelioma and their families. It is sponsored by Kazan McClain Satterley & Greenwood. Since 1974, Kazan Law firm has worked tirelessly to help the victims of asbestos exposure and mesothelioma.

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