What are you willing to lose? Risk tolerance can be applied to many aspects of our lives, with one of the most important being our financial situation. How much risk are you willing to take to gain returns? This might be a complex question with no easy answer.
Everyone is different, and where you fall within the spectrum of risk tolerance will guide your decisions. But when it comes to investing, how do you determine what risks you are willing to take? Where do you stand on the spectrum?
To assess your risk tolerance, you need to pose hypothetical difficulties and worst-case scenarios.
One question everyone should ask themselves is, if your investment portfolio suffered a 20% loss in a year, what would you do?
In such a scenario, would you be able to sleep at night? You might be the type to pull out remaining funds and opt for low-risk products.
Alternatively, are you the kind of person willing to invest more funds in stocks to buy in on a dip?
Some might choose to stay put with their investments, waiting for the inevitable market adjustments.
Determining your choices in this hypothetical scenario will greatly help decide where you stand on the risk spectrum.
Usually, the longer you wait to access funds, the higher your risk. Therefore, age typically affects where one falls in the realm of risk tolerance. But other factors also play a role.
Compared to someone in their fifties, individuals in their twenties can usually afford to wait longer to acquire assets or returns. A 25-year-old can take on more risks because they have time to recoup any losses.
However, for someone who is 55, facing retirement, they might approach investing more cautiously.
The longer you have before needing to access assets, the stronger your risk tolerance.
When determining risk tolerance, how one earns income is a crucial factor. Those with stable, consistent monthly incomes are often more willing to take on risks. They know exactly how much they can earn and how long it would take them to recover potential losses.
People reliant on commission-based work and unsure of their monthly income might not be as open to risks. They may be uncertain of their ability to recover losses or even bear them. The same goes for individuals running their own fluctuating income businesses.
Those with higher incomes generally can handle risks better. Higher earners might have the means to recover losses and have the opportunity to try again.
Young couples with children usually go into savings mode. Any extra funds they can find are oftentimes saved for education or home purchase, usually indicating lower risk tolerance.
People without children who may need to support elderly parents might also be financially stretched.
Individuals without family obligations might find it easier to take on higher-risk ventures.
Just because two people get married doesn’t mean they have the same risk tolerance. In fact, their views on risk might be entirely opposite. In such cases, a balanced approach is advisable.
Urgent cash needs will influence your risk tolerance. The more pressing the need for cash, the lower your risk tolerance. If you have a major expense looming, just the thought of possibly losing money could keep you up at night.
How is your investment experience? Without understanding investments, you can’t determine your risk tolerance.
Setting up an online brokerage account and stock selection might seem straightforward. But how much do you truly understand about it? Seeking advice online could backfire and lead to losses.
Before opening an account, some research is necessary. It’s crucial to align your investments with your knowledge and risk level.
Avoiding risks is normal, especially if it keeps you awake at night. But remember, completely foregoing risks might hinder you from achieving overall goals.
If retirement is still decades away and you are unwilling to take on any risks, you might feel unfulfilled in the future. Considering the factor of inflation, this becomes even more pronounced.
When striving to achieve goals, you might want to adopt strategies that have the potential to overcome inflation.
Conversely, an aggressive investor nearing retirement might wish to downsize their investment scale. This is especially true if their portfolio is primarily stocks. There might not be enough time to recover from a major recession.
As time goes on, your risk tolerance will shift with changes in your goals. Thus, frequently reviewing your investment portfolio is crucial.
You might also consider consulting a financial advisor to help assess risks and determine the best course of action tailored to your situation.