What is Your Investment Risk Tolerance?

Your risk tolerance plays a crucial role in your plan for growing your money without having to monitor it constantly. Risk tolerance is considered the ability and willingness to accept a decline in the value of your investments. This tends to happen when the stock market has large declines. When you’re ready to invest, you’ll need to consider the amount available to invest and what your financial gain is over a specific period. You may be specific about these factors or maybe you only care about how much you stand to lose or gain. For your peace of mind, it’s helpful to determine your risk tolerance for your investments. Understanding your wants and desires in relation to your finances will also help to determine how you decide to allocate funds.

Risk tolerance is one of the fundamental issues to consider when planning your investment strategy, either by yourself or with the aid of a professional. By understanding your risk tolerance, you can create a strategy for your investments that will help you to balance the stress of volatility with the potential for larger returns when looking at the big picture. If you reflect on COVID-19 when the market tanked in March 2020 you can truly assess your risk tolerance when the market is falling. What did you do in March? Did you hang on or did you sell your stocks? If you sold during the panic, your risk tolerance was low. If you were willing to invest more to take advantage of the market sell-off your risk tolerance was high and has served you well as the stock market sets record-breaking numbers.

Answers to the following questions will help you determine your level of risk tolerance regarding investments:

How much are you willing to risk? Based on how much money you currently have, how much of it are you willing to risk in an investment? Some people will say, “no problem, let’s go for it” regardless of how much they’re worth. Others, however, will carefully evaluate their financial worth and be willing to risk only a certain percentage of their overall wealth.

Are you okay with no cash flow? Can you accept no investment cash coming in for a while if a large investment goes south? If so, for how long can you put up with this situation? Being able to live with no incoming money is difficult for most people. How well you accept this situation is an important determinate of your risk tolerance.

Do you think an investment is “doable”? If you are considering a specific investment, do you feel the investment is one that you could make without hesitation? Each person has their own thoughts and ideas about the types of investments that promote confidence. Your investment risk tolerance depends on the rigor with which you evaluate your potential investments.

What is your experience in investing? Are you able to adjust to money losses in the short term to gain funds over the longer term? If you’re 40 years old and you’ve been investing for 20 years, you’ve got two decades of experience. You can most likely trust in your prior investment experience when it comes to making decisions. These years of investing build a lot of confidence, which strengthens your risk tolerance. But if you’re 35 years old and making your first investment your risk tolerance will be lower.
What is your age and how much are you worth? Age is a factor that comes into play when making difficult decisions about how to invest your money. In general, when you’re younger you may have more tolerance for loss because you have ample time to make up losses before you retire. Also, independent of age, the higher your net worth, the easier it may be to tolerate a loss of a small percentage of your worth.

Types of risk tolerance

Conservative risk tolerance This type of investor is focused on preservation of capital and the avoidance of downside risk. This means lower returns, but the investor will settle for that in in exchange for avoiding downside risk. An older investor who is closer to retirement will likely have a fairly conservative risk tolerance.

Moderate risk tolerance These investors keep one foot in two camps: they straddle conservative and aggressive tolerance. An example is a 60/40 allocation between stocks and bonds, this strikes a balance between growth investments (stocks) while also having stability for income generation (bonds) at the same time.

Aggressive risk tolerance This is when the majority of an investor’s portfolio is allocated toward riskier assets such as stocks and real estate. They offer the prospect of higher returns over time. However, there is no guarantee that an investor will actually get the money back. Being aggressive means being willing to accept the chance that you will come out of the situation with less principal.

If you would like to determine what your risk tolerance is, you can click the link for Research Investment Risk Tolerance Assessment. Produced by Missouri university, the assessment is anonymous and contributes to the knowledge in the field. It includes questions like what are your investment objectives and how would you react if you lost 20% of your portfolio?

https://pfp.missouri.edu/research/investment

Investment risk tolerance score

Key Level

Score

33-47 High tolerance for risk

29-32 An above-average tolerance for risk

23-28 Your have an average tolerance for risk

19-22 You have a below-average tolerance for risk

0-18 You have a low tolerance for risk

It is important to know your level of investment risk tolerance because making investments is integral to you and your family’s financial future. It is helpful to be intimately connected to your feelings and ideas about investing your money and the risks involved. If you choose to answer these questions, you should be able to successfully determine your risk tolerance for investing.

What is Your Investment Risk Tolerance?