Key takeaways:
Every investor's risk tolerance is personal, shaped by factors like income stability, time horizon, and financial obligations — identifying your own "sweet spot" is the first step in your investment strategy.
Building a dedicated emergency fund in a high-yield savings account can help protect your long-term investments by covering unexpected cash flow gaps without forcing a premature sale.
Having a proactive risk-management plan that accounts for both market shifts like interest rate changes, and personal scenarios like income disruption — can help keep your long-term financial goals on track, no matter what comes your way.
Weighing risk versus reward is top of mind for any investor. If you're just getting started, do you know your risk tolerance?
Find out with our risk personality quiz:
5 ways to help create a risk-management plan
Thinking through these five what-ifs can help you build a more resilient, long-term investment approach.
1. What if inflation increases?
Inflation is a sustained rise in the price of goods and services over time. In other words, during a period of inflation, the things you buy get more expensive. If the returns on your investments don't increase at a similar pace, your purchasing power can erode.
While no investment strategy can completely hedge against inflation, you might consider:
Choosing investments like real estate, gold and commodities that are less likely to be negatively affected by rising prices
Focusing on investments that are less sensitive to inflation, such as long-term bonds
Read more: How working with a personal advisor can help you better mitigate risk
2. What if the market becomes volatile?
Market swings are a normal part of investing. So while you can't escape volatility completely, you can take certain steps to try and manage it:
Diversifying your portfolio to include a mix of securities with different risk profiles
Choosing investments that aren't highly correlated with one another (meaning they each react differently to market volatility)
Avoiding herd mentality or emotional investing that might tempt you to sell when everyone else is selling or buy when everyone else is buying
Leveraging dollar-cost averaging
3. What if there’s an interest rate hike?
Managing risk during changing rate environments means understanding how rates can affect different investments. Some ways investors might manage rate moves include:
Investing in shorter-term bonds when rates go up, since they may be less sensitive to price declines
Utilizing a sector rotation approach to attempt to keep risk in check through periods of rising or falling interest rates
Focusing on long-term objectives rather than making reactive portfolio decisions
4. What if I lose my job?
In an ideal world, you would continue investing while looking for your next job. But that might not be possible, depending on your personal financial situation. So while you might have to pause actively funding your accounts until you have income again, try not to cash out your current investments unless absolutely necessary.
If possible, consider:
Reconfiguring your budget to accommodate
Dipping into your emergency fund rather than selling long-term investments
Continuing to invest at reduced levels
If you do need to sell your investments in the absence of income, know this move has tax implications. Doing so will also cause you to miss out on the power of compounding returns, which can mean less earnings potential in the long run, though investment performance is never guaranteed. And for the nearly 60% of American households that have retirement accounts, remember: Early withdrawals can also result in tax penalties. Evaluate all your choices when deciding what will best help you pursue your financial goals.
5. What if I have a financial emergency?
Building an emergency fund can allow you to continue investing even when a curveball comes your way. Backup funds can help manage risk by ensuring you don't have to sell off investments to cover cash flow gaps.
If you need to start one, consider creating a bucket labeled “Emergency Fund” in an Ally Bank Savings Account so you can clearly see how much you have saved for a rainy day.
You can’t avoid risk, but you can plan for it
Once you know where the sweet spot between your risk tolerance and risk capacity lies, you can create strategies for your investment goals.
