Photo: Towfiqu barbhuiya / Unsplash
The biggest dilemma for any investor – especially a beginner – is figuring out how much risk you are comfortable taking. Investing in anything is a game of winners and losers. Sometimes you win, sometimes you don’t, but you have to be willing to lose once in a while to play the game right.
The question is…
How much market volatility can you tolerate, and how much are you willing to put at stake to win?
If you’re ready to figure out your investment risk tolerance, ask yourself these important questions:
1. What Do You Hope to Achieve with Your Investments?
Whether you’re planning to invest in commercial real estate, play the stock market, or embrace some other investment opportunity, you need to identify your goals. Maybe you’re saving for retirement, or perhaps you want to fund your children’s education. You might even want to buy a house in the future or simply become financially independent. Having a goal for your investments will help you figure out how much risk you’re willing to take to reach it and how much money you’ll need to get there.
2. What is Your Timeframe?
How long will it be before you need to use the money you’ve invested? This is your timeframe. Knowing your goals and your timeframe will give you valuable data for determining your level of risk tolerance.
For example, the longer your timeframe – say saving for retirement – the more risk you can take as there is more time for your investment to recover from a downturn. If you have a shorter timeframe in mind – saving for a down payment on a house, for instance – you can’t afford to take as many risks as there isn’t as much time for your investment to recover.
3. Are You Comfortable with a Short-Term Loss?
Depending on your goals and timeframe, you may or may not be comfortable with short-term loss. Certain investment opportunities are notorious for short-term losses that balance out to profits over time, thanks to a generally positive trend.
If you have a long timeframe for your investment, a short-term loss may not be a big deal, but if you plan to cash in your investment soon, a short-term loss may be detrimental to your goals. This is why many investors diversify their portfolios with various investment types. This tactic ensures that a loss in one area doesn’t cause a complete breakdown of their investment goals.
4. Do You Have a Savings Account?
It’s important to have a savings account you can draw from in a financial crisis. Access to quick cash means you won’t have to liquidate investments to remedy emergencies. In turn, this can give you more room to play with risk.
Of course, if you already have a lot of money in your savings account because you’re afraid to invest it, this is a clear sign your risk tolerance is very low.
5. How Often Do You Plan to Track Your Investments?
If you obsessively track your investments daily, and the downturns in the market make your stomach drop, you may not be as risk-tolerant as you’d like to think. By contrast, if you actively scan the paper or the internet for new investment opportunities rather than monitoring the ones you already have, you may be ready to take on more risk.
Investing always carries some level of risk. It’s often said the bigger the risk, the bigger the reward, but you must decide just how much risk you’re willing to take to reach your goals. Answering the questions above can give you a good idea of the level of risk you’re willing to take.
