Determine the risk level of your existing portfolio.
When we think of risk levels, it’s natural to think of it in terms of risk tolerance—that is, the appropriate portfolio risk that a person would be most comfortable taking. Risk tolerance can be a delicate balance between emotions and financial reality. But the risk level of your current portfolio is a different thing altogether. Your risk tolerance has nothing to do with the current risk exposure of your portfolio. For example, I had a new client whose risk tolerance suggested they needed a 30/70 portfolio because the highest downside they could emotionally stomach in any year was 17%. They were in a 100/0 portfolio in four stocks where the highest downside in any one year was 45%. Yet they were perfectly comfortable with the 100/0 portfolio, simply because all it had done since they owned it was to go up. They had no idea they were sitting on an investment powder keg.