One Answer Does Not Fit All: Your Tolerance for Risk

Usually, this question comes up following an unexpected windfall of cash – sometimes due to an inheritance, a severance package, a settlement, a retirement payout, or even a lottery win. Often, it’s after years of disciplined savings finally reaching a goal, or a promotion or new job bringing an increase in discretionary income into the household that needs to be directed to the appropriate place in the family budget.  Regardless of the source of the cash, the decision is the same: What do we do with it?

There is a plethora of studies and research available at your fingertips to help you determine if the math makes more sense one way or the other – to pay off debt or invest. Data like interest rates, time periods, principal, risk tolerances, etc. will be used to help make comparisons and run calculations. You can plug in your data, and the calculators will spit out the numbers you are searching for. It’s all very black and white, and the math can make perfect sense. The answers could help you determine if today’s market and interest rate environment may be better suited for debt reduction or
investment opportunity. This is strictly a numbers comparison. The calculator is helping you determine if, based on all the data you input, you could ultimately make more money at the end of the hypothetical period paying off debt or by investing the same amount of money. That aspect of the choice is just a math problem. One can easily run these scenarios and compare numbers on paper to find what the statistics may show as the optimal choice for them, but investing is so much more than numbers on paper or a computer screen.  

Which approach is right for you really depends on how you feel about and how comfortable you are with debt and how comfortable you are with the risk you take on by investing in the market. The average person has to ask themselves, “What is my tolerance to risk?” and answer honestly. Everyone has a different tolerance for risk, and oftentimes, those tolerances change based on economic cycles, current events, personal experiences, and so on. Risk tolerance is not static – it’s a variable that applies to both debt and investments. 

Everyone has a different tolerance for risk, and oftentimes, those tolerances change based on economic cycles, current events, personal experiences, and so on. Risk tolerance is not static.

For some, debt brings more stress, sleepless nights, and worry. Assuming we are always referring to investments as we speak about risk tolerance is incorrect. Each personal situation is unique and has to be dealt with individually. There is no universal answer to this question, no matter how many times it’s asked. 

The need for cash and an emergency fund is also a factor used while considering
this question. Paying off debt can eliminate a cash reserve and leave no access for an emergency or liquid fund. Most financial advisors will agree that three to six months of cash in an easily accessible account is something everyone should have regardless of their financial situation. This should be established before any debt reduction or investment plan is considered.

The answer I or anyone else can most consistently and confidently offer is to make sure you are asking yourself the right questions, provide full, honest, and thorough answers, and seek counsel from trusted professionals who can help guide you toward making the best possible decisions to meet your financial goals.

Securities offered through Raymond James Financial Services, Inc., member FINRA/SIPC. Investment advisory services are offered through Raymond James Financial Services Advisors, Inc. Round Table Advisors is not a registered broker/dealer and is independent of Raymond James Financial Services. Any opinions are those of Julie Davis and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice.