Want to know how to calculate your investment risk tolerance? Read this article and tap into a couple of free resources that may help you sleep better at night. It’s no fun taking too much risk and finding out after the fact!
As an investor, it’s crucial to understand your risk tolerance. Jumping on an investment opportunity without grasping the concept of risk tolerance can mean losing some or all the money you invest. Protect yourself from unnecessary or avoidable investment losses by learning how to calculate your risk and the potential reward for taking a risk.
What is Investment Risk Tolerance?
Investment risk tolerance is the degree of statistical variability you – the investor – are willing to withstand. Your risk tolerance is, in essence, what you can comfortably lose based on the potential swing in the value of your investments. Taking on too much risk can mean a bad investment and lost money. On the other hand, taking less risk than you comfortably can will likely mean less of a return. Gauging your risk tolerance will enable you to invest wisely.
Several factors affect risk tolerance. First, review the different asset classes and research worst-case scenario investment returns for each. For example, if a bad year for a certain stock lost investors thousands of dollars, be prepared to lose the same if the stock has another bad year. Be prepared for anything because we never know when we’ll see the next Black Swan, like we did leading up to the Great Recession.
Reviewing the worst-case returns for the asset classes you’re interested in will help give you a better idea of what you might lose. Risk tolerance also depends on your investment time horizon. The time horizon is the length of time you make or hold your investment before you liquidate it. Different investments will have different time horizons, and this will change its nature. For instance, a long-term investment may have more room to be aggressive, since short-term losses may not matter in the face of long-term gains.
To calculate your risk tolerance, look at your future earning capacity and assets you have (i.e., a home, Social Security, or pension). The more stable assets in your favor, the more risk you can afford to take during investments. The more able you are to work longer, save more, the less the pressure can be on “saving and investing” for retirement, especially if you love your work and want to stay “on purpose” with what you do to create income.
How to Calculate Your Risk Tolerance
The best way to calculate your individual investment risk tolerance accurately is by using a free online questionnaire, such as the one offered by Rutgers University. This free quiz asks questions about your nature as a risk taker, decisions as an investor, and level of comfort making investments.
There are many quizzes available on different investment and financial advice websites. Take more than one to compare your results and receive a second opinion. Listen to your heart more than your head. Over time, you will learn to manage your emotions so you’re able to make confident, clear decisions on your investment risk and how to manage your portfolio, especially if you do it all on your own.
Not everybody is confident making their own investment decisions. If this is you, consider discussing your goals and risk tolerance with a professional investment consultant or adviser you trust. Your personal consultant can get to know you as an investor and achieve a firm understanding of your assets and investment portfolio. A consultant can tell you your risk tolerance and give you excellent investment advice according to high industry standards.
Once you understand your risk tolerance, you’ll be able to diversify your portfolio with confidence. You won’t have to worry as much about making unwise investments, or losing more in a downward swing than you can afford. With your risk tolerance in mind, you can protect your assets and become a savvy investor. Discover your risk tolerance today using a free quiz or by working with a consultant, and make a smarter investment tomorrow.
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