Very often when I explore with people why they are asking me for advice, I discover that they have taken what I consider too much risk in their portfolios. Many times they have little or no buffer from fixed-income funds. Too much in equity, in other words.

Other times, they don’t have proper diversification. After the past five relatively favorable years, investing may have started to seem easy and safe. That feeling led some people to invest heavily in commodities, real estate, sector funds and whatever else seemed to be on a tear at the time. In my book, this is a serious mistake.

The recent market may not seem warm and fuzzy to those investors who have followed our advice over the years by diversifying properly and including fixed-income funds in their portfolios. But those people are not experiencing panic. They are not freaked out about their futures. They know that their investments are designed to get them through periods exactly like this, even when it doesn’t feel comfortable.

I’ve talked to thousands of investors over the years, and if I had to guess I would say that the majority of them routinely take on too much risk. When they make those decisions, it usually feels good. Hope and optimism are always popular. Unfortunately, taking high risks almost always involves unpleasant consequences.

Here are 10 unintended consequences when investors pay too little attention to how much risk they are taking:

1. You can lose more than you need to. In the past I have promised investors that they will lose money, at least temporarily, if they are invested in the stock market long enough. Losses are a given, to be expected.  But if you carefully and thoughtfully control your level of risk, you will also control your level of losses. To pick a number that may be appropriate for many people but certainly not for everybody, you may “need” to be prepared to withstand losses of 12 to 15 percent in a year. There are portfolio combinations that will subject you to that, but not more. However, if you take too much risk, you could easily find yourself down 20 or even 25 percent in a bad period. That’s unnecessary. In addition, taking more risk often involves more trading. That can mean higher expenses and higher taxes, both of which can erode your gains and magnify your losses.

2. You can come upon your retirement date with too little money to meet your needs. This of course is usually a direct consequence of the first item, losing more than you need to. If you lose too much when you’re in your 30s or 40s, you have time to learn from your mistake and recover, even if that means you have to increase your rate of savings. But if you run into a bad bear market just before your retirement, you may be stuck. If you start retirement without enough money, your necessary withdrawals could lead you to the ultimate risk: running out of money before you run out of life.

3. You may have to postpone retirement and work longer.  Many people indicate that they want to keep working, at least on a part-time basis, after their standard retirement age. The key here is the element of choice. If you choose to work longer, that can give you economic and non-economic benefits. But if you have no choice about it and simply must work longer, the enjoyment from working will probably have an unpleasant edge to it. You may feel resentful of others in your age group who seem to be free of economic worries. (Trust me, most of them are not really worry-free.)

4. You may have relationship problems.  If your spouse or partner has left all the investment decisions in your hands, you might want to be the hero and get the “home run” from a spectacular investment. But if you strike out with money your family is counting on, you could be deep in the doghouse. I’ve known many couples in which one person was a risk-taker and the other was conservative by nature. One of the most common problems in marriage is financial troubles. If those troubles lead to divorce or separation, that can become extremely costly. So it pays to be on the same page with your mate when it comes to risk. It can be mighty uncomfortable to be the one whose actions are the “cause” of joint financial troubles.

5. You may own and hang onto investments that have essentially died.  You can feel certain that an investment you’re making will do well over the long haul. And you can be wrong. If you have an emotional attachment to a risky investment that has gone sour – or if you aren’t willing to face up to your losses and cut them off – you can hold on for years to something you should dump – hoping that it will at least break even so you can sell and get your money back. Yet even if you get back to your break-even point, there’s a big opportunity cost. That means you will have passed up the opportunity to do something else, something more productive, with your money while you are waiting.

6. You may sell too soon, at the wrong time.  This is really the opposite of the last item I discussed, but it happens frequently. In fact, it’s been happening to some investors recently as they bail out in panic. Rigorous studies over many years have shown again and again that investors tend to overreact to market downturns by selling, even though that runs counter to their long-term plans and counter to their belief that they are buy-and-hold investors. This can be a vicious trap, without any good escape. If you have lost money and you’re sure you should get out of the market to cut your losses, how will you know when to get back in? If you wait until it feels like the right time, that will almost certainly be after a substantial rise in prices – an advance that has passed you by while you are on the sidelines. The next item on my list is very similar.

7. You may stop putting money into the market because it doesn’t seem safe.  Even if you avoid bailing out, you may decide not to “throw good money after bad” and you may stop making new investments. The same problems result. When will you resume your savings program? How will you make up for the lost opportunity of the money you didn’t invest?

8. You may think you’re taking just a little extra risk, and be wrong.  Many people think they can successfully take excess risk with only a small part of their portfolios, and limit the damage that way. If we weren’t emotional beings, that would work just fine. But in too many cases, I’ve seen people panic over some part of their portfolio and behave as if losses in one risky asset class would somehow contaminate the rest of what they have. They may sell everything and be right back at item No. 6 above.

9. Taking too much risk may lead you to take even more risk. Imagine that you are coming up on retirement and you clan plainly see that your nest egg won’t meet your needs because of your poor choices in the past. There are several possible responses to this. One of the worst, unfortunately adopted by many investors who see it as their only option, is to take on even more risk in the hope of “catching up” to where they thought they would be. This just escalates the cycle. And it increases the probability of experiencing all the other consequences in this list.


10. You could make your heirs pay for your mistakes.  Even if you dodge all the consequences I’ve outlined so far, even if you manage to get through your retirement successfully, the results of  risky investing can live after you are gone. It’s possible that taking excess risk will mean you leave a lot more money for your family than if you had been prudent. But I think it’s more likely that you’ll leave your family a lot less. You might care about this, or you might not. That’s up to you. For me, an important objective of a lifetime of investing is to leave money to my family and to charitable organizations I believe are worthy of my support. I believe I’m much more likely to achieve that objective through prudence than through excessive risk-taking.

The way to avoid these unpleasant consequences is to figure out your real risk tolerance and then embark on a diversified investment plan that’s designed to keep you within your comfort zone. Exactly how to do that is beyond the scope of this article. But you can get a great start by studying an article called “Fine tuning your asset allocation.” You’ll find a link to it on the home page of FundAdvice.com.