What is your risk capacity?

Your risk capacity is as important as your risk preference. Even if you have a very high tolerance for the ups and downs of the market, you must have the time necessary for your investments to recover.

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How much will you need in the next 12 months?

Money that you know will be spent in the next 12 months should be in CD's, high interest savings, or short-term, high-quality bonds.

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How much will you need in the next 6 years?

Funds you will spend over the following 6 years should be in bonds rather than equity, for the most part.

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do you have any health problems or job/income risks?

If you have significant health problems or your income is unstable, you should plan to put some of your investment funds in bonds to compensate for that.

Example 1:

John Doe will retire next year and begin withdrawing 5% a year for retirement. In the next 12 months he will make no withdrawals. In the following 6 years he will withdraw 5% times 6 years, or 30% of his portfolio. He is in good health, so he should have a minimum of 30% of his portfolio in bonds.

Example 2:

Jane Doe is 40 and plans to retire at age 67. She has no plans to use any of the money over the next 7 years, but she has her own business and sometimes has 3-4 month periods when her income is much lower. Jane should put at least 3-4 months of income into short-term bonds at a minimum.

Example 3:

Jeff Smith will attend college beginning next year. He plans to use his entire cash balance over the following 4 years. Following the pattern above he would not put any of his funds in equity. However, an all bond portfolio has about the same risk characteristics as a portfolio with 20% in stocks. Jeff will benefit from a 20/80 allocation.