Doesn’t it seem like folks love to take risks when markets are booming, but absolutely hate it when markets stink?
A question I often get is, “What kind of investment will give me good returns without the risk of losing my money!?” Well, when you find something like that let me know!
Unfortunately, too few people assess their investment risk properly and then second-guess themselves when markets behave poorly.
So let’s take a look at three main components in determining your risk tolerance and let’s help you avoid sleepless nights and create a better investment strategy for your goals.
1. Your Age
Typically speaking, a younger person can take on more risk. If something doesn’t go quite right, you have more time to make up any losses.
For example, if you are in your late twenties or early thirties, you might have another 30 years or more before you reach the retirement finish line, which means you’ve got time on your side and can probably ratchet up your risk for a while.
If you’ve only got 10 years to go til retirement, you may want to reign in that risk a bit and shore up what you have.
I’m speaking in general terms here. I know some younger folks who don’t like risk and I know a few older ones who love to roll the dice!
2. Time Frame of Goals
This is so important! Knowing the goals you have for your money is key to determining risk tolerance. If you are saving for a downpayment on a house that you plan to buy within the next two to three years you certainly don’t want to be going “all in” because you’re going to need the money soon and you don’t want to lose what you’ve got.
On the other hand, if your goal is college funding for your week old baby, you can probably bump that risk up a bit. Knowing the purpose for your money helps figure out your time frame – and that helps determine how much risk you really should be taking.
3. Comfort Level
This is the trump card in determining risk tolerance. If you live life as if there is no tomorrow, you are probably okay with taking on some significant risk in your portfolio.
If you’re the type of person who drives five under the speed limit, doesn’t like to light candles in the house because it might cause a fire; or you check all the doors, twice, to make sure they’re locked before you go to bed – you are probably a pretty conservative person.
Knowing your comfort level is a key to managing risk and expectations for your investments. Here’s a couple areas to delve into further in terms of comfort levels:
Your Reflex
Of course we all know that investments go up and investments go down – it’s the nature of the beast. The question is what do you do when things don’t go as planned?
In other words, what is your reflex – your gut reaction. What is your response to a 10% dip in the market? Are you the type of person that rolls with the punches and understands that markets sometimes do this? If so, maybe you can take on a little more risk.
If you can’t stomach receiving your brokerage statements in the mail because you might see some negatives, then you probably need to ease up your risk.
Your Emotions
Are you an emotional basket case? Does your tolerance for risk depend on what the media says, a bad week at work or every little dip and dive in the market? You might be prone to making emotional decisions.
Emotional decision-making can hamper your growth, leave you with a lower return and is often one of the biggest reasons why folks are off track for retirement. You’re probably better off reducing risk a degree or two over the long run than shifting your portfolio around every time you think the market is going up or down.
Investing can be a great endeavor when handled correctly and aligned with who you are as a person. Understanding your situation, your goals and your comfort level will help you navigate through difficult markets and keep you from making poor decisions.
{ 5 comments… read them below or add one }
Jason,
Great article. You hit all the important points. I find that putting your investment strategy in writing keeps you on track and accountable.
Betty, that’s a good point. I think it’s important to have a strategy written down and reviewed often so that if you stray to far off track you can always revisit and get back where you need to be.
“If you’ve only got 10 years to go til retirement, you may want to reign in that risk a bit and shore up what you have.”
I think you mean ” …you may want to rein in that risk …”
Great article and very appropriate. I was quite the emotional investor when I was day trading. That is kinda a contradiction in terms, as day trading is more gambling than it is investing. Since then, I have picked a few stocks that look good on the books, appear to have good track records, and that seem as though the current socioeconomic and cultural trends will continue to support those companies. These days I do not watch my stocks everyday. I have confidence that in the long run they will win.
Guernsey – good catch!
Mitch – emotional investing is was sure-fire way to kill portfolio performance! Way to “rein” that in!!