10th
Your Investment Risk Tolerance: What It Is and Why It Is Important
Whether you manage your own assets or work with a financial counselor, more likely you’ve heard about investment risk tolerance.
By definition, Risk tolerance is “The degree of uncertainty that an investor can handle in regard to a negative change in the value of his or her portfolio” (Risk tolerance, 2010).
In other words, risk tolerance is a measure of how much you are willing to lose when the business goes down. Most Americans knew what their true risk tolerance when financial crisis broke out – not the best time to find out.
Best way to know your risk tolerance is to answer a questionnaire. You can use those that are available online or at a financial adviser’s office.
There is no generic questionnaire, but they all have almost the same questions, example:
- When will you need the money from this particular account?
- What are your plans for this investment?
- What is your net worth?
You don’t have to worry because, there are multiple choices and there most of the time not that many. You will be categorized according to the result of your answers.
There are 3 types of risk tolerance: conservative, moderate and aggressive. Regardless, the often used charts are moderately conservative and moderately aggressive risk tolerance as well. It is important to be aware of your risk tolerance because it is the very foundation of putting up a personal investment portfolio. Differences in risk tolerance promotes different combination of fixed and equity investments as well as growth and value investments in the given portfolio.
Conservative investors have the lowest risk tolerance; because they choose not to sacrifice any money or to lose very little. Obviously they are also willing to negotiate for a lower return. They stay with investments with guaranteed rates of return such as money market accounts, CDs and bonds with very little hazards to stocks. The basic combination of fixed and equity investments in a conservative portfolio is 80/20.
Moderate investors can stand some gamble; it’s either they have plenty of time before they need the money or they have many of assets to compensate for the losses. Oftentimes moderate portfolios call for around 50/50 combination of resources.
Aggressive investors can carry the most risk in hopes of getting the highest returns. They often have high net worth and can invest in such instruments as real estate investment trusts, unit investment trusts, limited partnerships and other investment vehicles not available to an average American. Commonly the fixed-equity investment combination in an aggressive portfolio is 20/80. There are even some who goes for 100% in the market.
Before putting your investments and thinking of ways on how to get rich, make sure to know your risk tolerance and devise an appropriate investment allocation for your portfolio. If you are on the conservative side, a wrong allocation will make you anxious and panicky about losses. However, if you are a moderately aggressive or an aggressive investor, an overly conservative portfolio will leave you unhappy with returns.
