5 Steps to Determining Your Risk Tolerance
There’s a degree of risk in any financial investment. There are no sure winners and no sure losers, either. How comfortable you are with the latter statement may give you a clue as to your risk tolerance. You can think of risk tolerance not only as how much you are willing to lose on your investments but rather how much uncertainty you can live with from day to day.
Are you the type to sit and watching to stock ticker pass by all day? If so, does it fill you with dread or excitement? These are the kinds of questions you should be asking yourself. The answers will, in turn, help you pick out an investment portfolio that’s right for you.
1. A Personality Test
The individual identity component of risk tolerance assessment shouldn’t be ignored. Some of your risk tolerance can be measured, meaning that the amount of risk you can tolerate is based on factors like your age or your income. However, you may simply dislike making risky investments. That’s okay. You should be comfortable with spending (or not) your money the way you like.
2. What are Your Financial Goals?
Do you save money to accumulate wealth or are you looking for ways to retire early? If your only goal is to have a nice pile of money to retire on when you’re 70, slow and steady may be your investment pace. You’re looking to have a steady accumulation over time that will be just enough for a happy retirement. If you want to go out while you’re relatively young, you’re looking for investments that are a high risk/reward ratio. You don’t mind some volatility if it can get you to the finish line faster.
These retirement-focused goals aren’t the only goals that can impact your investment strategy. You may be saving for a house or considering buying a business.
3. How Much Time Do You Need?
If you’re relatively young, theoretically you have plenty of time to ride out the peaks and valleys of the stock market (whether you can handle the emotional reality is a different story). You can tolerate a little more risk by design. If you have a goal you need to meet quickly (buying a home) or you are nearing retirement age, you may want to think more conservatively so that you don’t lose too much money. With home buying it's more important the money is there vs. getting an astronomical return.
4. Your Wealth and Income
If you have $5 million to invest, you can take more chances than you should if you have $50,000. Size your investments appropriately. That’s fairly straightforward. You may also consider additional factors, such as the amount of debt you’re carrying, or whether your personal ecosystem (job, family, assets, etc.) is strong and stable.
5. Get Good Advice
Working with a financial planner can reveal clues about your risk tolerance and map out a strategy. You can prepare yourself for the discussion by looking at one of the many online questionnaires that can help you look at yourself. You can ask some of the more obvious questions yourself, such as, what would you do if presented with $25,000 to invest, what would you do if the stock market dropped 20%, or whether you like to participate in extreme sports.
Even after you’ve asked yourself the tough questions, you may still want to talk about risk tolerance and assessment with an experienced financial planner. If you have a partner, discussing risk is paramount. Couples may not agree when it comes to investment risk. You may find that you are not as risk averse or risk tolerance as you thought. You can learn about yourself and make better decisions regarding your future.
This content is developed from sources believed to be providing accurate information. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security.