What is risk tolerance? New investors often hear that risk tolerance is key in deciding how, when and where to invest. Every person has a specific risk tolerance that should be considered before investing. Good stock brokers and financial planners understand this fact, and should help their clients to determine their personal risk tolerance before buying stocks, although not all of them do it. You should also understand and be aware of your tolerance level to be able to find investments do not exceed it.
Risk tolerance simply means how much risk you are willing to expose your investment funds to. If you are not afraid to lose money if you will gain in the long run, you can afford a high risk tolerance. If on the other hand you are anxious about losing your principal even in the short run, and want your money to be safe, that is a low risk tolerance. The higher the risk, the higher the returns, but also the higher possible losses. For low risk, returns may be less, but the probability of losses to your nest egg are lower or non existent.
To determine your risk tolerance, you should take into account a few issues. You should start by knowing how much money you have available to invest, meaning money you can afford to lose. Also decide what your specific investment goals or long term financial goals are.
For example, are you saving for retirement? With along time horizon, you may have a higher willingness to take on risk, to achieve higher gains over the next fifteen or twenty years. If you plan to retire in five years, a low risk portfolio will keep your money safe from short term swings that could cost you.
There is no cut and dried formula that works for all investors. Whether you have a high risk tolerance or a low risk tolerance may only partially be determined by your feelings about risk. Can you tolerate losses in the market? Do you react emotionally and pull your money out? Or do you feel comfortable that your portfolio is designed to weather the short term ups and downs? With a low tolerance, you are likely to sell, and constant selling and buying can cost you in fees as well. Keep your money in lower risk vehicles and avoid losing over the long run.
If you have a long time horizon, you can afford higher risk,but may not emotionally be able to live with risky investments. The choice is yours as to where to invest today, based upon your own needs: whether to go for high returns and high potential losses, or take the slow and steady lower return path of low risk. It’s up to you to decide.
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