What’s your investment risk tolerance?
Risk is a normal part of investing. If you didn’t take on any risk, you wouldn’t have the potential to achieve higher returns. But how much risk should you accept?
You don’t want to incur unnecessary risk. So, you’ll need to assess the amount of risk you’re comfortable taking and then determine if this risk level supports your ability to achieve your long-term goals.
Here are some of the key factors in determining your own capacity for investment risk:
- Personality – We all have different personalities. And your individual personality can certainly affect your comfort level with risk. If you enjoy taking chances or pushing yourself outside your comfort zone in other aspects of your life, you could be more likely to accept greater investment risk, too, because you know that greater risk means greater potential reward. Conversely, higher-risk investments also carry greater potential for volatility, including steep short-term declines.
- Time – Risk tolerance can change over time. When you are first starting out in your career, with decades to go until you retire, you may feel comfortable with a certain degree of investment risk, knowing you have time to potentially overcome the inevitable downturns in the financial markets. But as you near retirement, you might consider lowering your risk level and investing more conservatively, because once you do retire, you’ll likely have to start withdrawing money from your retirement accounts, which means you may need to liquidate some investments – and, ideally, you won’t want to have large fluctuations in value at that time. However, even during retirement, you may want your portfolio to include some growth-oriented investments to help keep you ahead of inflation.
- Type of goal – You might have different risk tolerances for different goals. For example, if you know you need a specific amount for a particular goal in two years – such as buying a new car or taking an overseas vacation – you may want to put away money in a low-risk, liquid vehicle. This type of investment might not have much growth potential, but for this goal, you are less interested in achieving a high rate of return than you are in being reasonably sure the money will be there when you need it. So, in this instance, you may have quite a low tolerance for risk. But for a long-term goal, such as a comfortable retirement, you may be prepared to take more risk in the hopes of greater returns, given the longer time horizon.
By understanding your risk tolerance and knowing how it can change over time and under different circumstances, you can be better prepared to face investment volatility. And there are certainly things you can do to mitigate risk. By owning a variety of investments – domestic and international stocks, bonds, mutual funds, government securities and so on – you can reduce the impact of market volatility on your portfolio. (Keep in mind, though, that diversification can’t prevent all losses or guarantee profits.)
In any case, the biggest risk of all is simply not investing. If you are going to achieve your financial goals, you need to invest for them. By understanding your own risk tolerance, and by making wise choices along the way, you can stick with an investment strategy that can work for you in the long run.
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