How much investment risk are you willing to tolerate? Your investment goals, your personality and especially your emotional makeup determine your tolerance for risk. You can’t change the basic relationship between risk and reward, but you can and should choose your investment strategy based on your comfort level.
If you worry about your finances. If you’re primarily concerned with safety and the thought of losing money, even a little, makes you cringe, you’re probably a conservative investor. Your aversion to risk will help you sleep well, but you can’t expect high returns on your investments. You’re more of a saver than an investor.
If you’re the type of person who loves the feeling of adrenalin pumping. If you love the contest and are willing to throw the “hail mary” pass to win the game, then you’re an aggressive investor. The aggressive investor is willing to assume great risks in the pursuit of huge gains. Aggressive investing is certainly not for the faint of heart. Not when you stand to lose 25 percent of your investment overnight or 40 percent or more of your investment in a matter of weeks or months. If you have the stomach for it, the rewards (if they come) can be huge.
Most investors are moderate and fall between the two extremes. As investors, they understand that the market will fluctuate, sometimes wildly. They realize that they have to take some chances to achieve their desired rate of return. They recognize that they will lose money in a down market, but are willing to tolerate a moderate amount of risk in hopes of riding an up market for handsome gains.
Your age has a large influence on your risk tolerance. When you’re young, you have time on their side. You can afford to take greater risks and wait out market swings over the long term, but as you get older and approach retirement, you’re more interested in preserving your wealth. Your wealth building phase may not be over, just winding down, and you want to hang on to your hard earned assets.
People tend to more conservative as they grow older. This makes sense because the older you are, the more time you’ve had to accumulate personal wealth and the more you have at stake. If you’ve already made all or most of your money, then why put your gains at risk?
Age isn’t the only factor influencing your basic risk tolerance. The purpose of your investment and the source of the funds themselves will determine if you are willing to increase or decrease that tolerance.
For instance, even if you’re aggressive with most of your investments, you won’t be willing to risk the funds set aside for your children’s education or money you’ve earmarked for a new home. By the same token, even the most conservative investor wouldn’t think of risking their principle, but might consider using windfall profits for a riskier investment.
People don’t fit into neat pigeonholes like conservative, moderate or aggressive. We change with the years and approach our differing investments with different goals. No matter where you are in the continuum, a truthful understanding of the risks you can tolerate will certainly make you a more comfortable and hopefully more successful investor. You’ll sleep better at night too.