Find Your Investment Risk Tolerance
It’s important to know your investment risk tolerance level. Why? Because ALL investments have risk, and some types of investment are (much!) riskier than others.
You don’t want to take chances you can’t live with, which means that in addition to knowing how risky the things you’re considering investing in are, you need to know two things about yourself when investing:
- How comfortable you are with losing your money; and
- How comfortable you are with not making enough money to meet your needs.
Really imagine it
If you suddenly couldn’t do the things you’d always assumed you could do with your investments — either because they were gone, or because you’d been way too conservative — how would you feel? And where would that leave you?
Essentially, that’s what figuring out your tolerance level for risk is in the context of investing.
Be careful here, because it’s one thing to say or think that you’re OK with various levels of risk, and it may be another thing to actually experience a huge loss or a huge lack.
If you’ve already experienced one of those things, you’ll have a pretty good idea of how you’ll feel and act. So start there. If not, try your best to imagine the effects of risk on your life.
Picture these scenarios
For example, consider this idea. Start planning a trip to a nearby casino. How much money will you take, and what will you do with it when you get there?
The more money you’re willing to bring, and the more games of complete chance you plan to play (slot machines, roulette) the greater your appetite for risk probably is. You’re likely to see a downturn in the stock market as an opportunity to buy, buy, buy — and to make too many risky buys, if you have little-to-no aversion to risk.
On the flip side, if you’d never plan a trip to a casino, or if you’d limit yourself to people-watching, bringing very little money, and sticking to games with at least an element of skill (like poker), you’re probably pretty risk adverse. You may not even have any investments. (Which is itself pretty risky, unless you’re fine with the likelihood of ending up in a government-run nursing home.) You’re also more likely to inadvertently sell low and buy high.
The third option, of course, is that you have a high tolerance for risk in some cases, and a big aversion to too much overall risk — including the risk of not taking enough risk.
That looks something like this: You go to Vegas, stick $40 on a single number on the roulette wheel, and then walk away afterward to people-watch for the day, win or (almost certainly) lose. Investing-wise, you put every extra penny into stocks when they hit a downward spiral, but make sure you have a good mix of investment types with your “regular” (non-extra) investment money — including a pile of cash and bonds.
You’ll be better prepared
In any case, once you’ve figured out how comfortable you are (or aren’t) with risk, you’ll be better prepared to start creating an investment plan that is more likely to meet your needs based on how you are likely to act or react in various investment environments. Knowing yourself is the step that gets it all started.