Your Risk Tolerance

This is where most financial advisors or investors go wrong, not properly accounting for risk tolerance. During the recent poor and volatile performance of stocks in 2008 and early 2009 there was not an investor whom did not have their risk tolerance tested. However, some investors were still happy and comfortable during those dismal times for the markets. Why? Because their risk tolerance was properly accounted for. Simple truth is, any individual whom was frustrated, angry, or complaining about the market conditions of 2008 and 2009 has improperly assessed, or was not properly advised on, their risk tolerance.

Assessing your risk tolerance will determine how comfortable you can be with your investments. If your risk tolerance is properly accounted for, no matter how much the markets fall you should still be comfortable and relatively happy with your investments.

Each individual has a risk tolerance that should not be ignored and rigorously understood before any of their capital is invested. Any good stock broker or financial planner knows this, and they should make the effort to help you determine what your risk tolerance is. Do not settle for any financial advisor to just give you a short survey or quiz of 10 questions and small talk for only 15 minutes to determine your risk tolerance. It goes deeper than this; after all, this is among the most important steps in your investing why should it not deserve as much time as anything else?

Determining one’s risk tolerance involves several different things. Mainly for your risk tolerance you need to be aware of your time frame, what you plan to achieve in that time-frame (goals), the amount of cash you have available to invest, and your age.

For instance, if you plan to retire in ten years, and you’ve not saved a single penny towards that end, you will be placed towards higher risk tolerance – because you will need to do some more aggressive – risky – investing in order to reach your financial goal.

On the other side of the coin, if you are in your early twenties and you want to start investing for your retirement at the age of 55, your risk tolerance will be low. You can afford to watch your money grow slowly over decades. In contrary, if you are in your early twenties you may be willing to take more risk because you have many years to recoup a loss or you may have the idea of retiring earlier at age 40 for example and live off of your investments

Realize of course, that your need for a high risk tolerance or your need for a low risk tolerance really has no bearing on how you feel about risk. Again, there are multiple factors in determining your tolerance.

For instance, if you invested in the stock market and you watched the movement of that stock daily and saw that it was dropping slightly, how would you feel? How about asking the question, "If I buy $X worth of this stock what percentage would it have to drop in one month that would cause me to be uncomfortable?" If a drop of over 5% is the threshold that would cause you to be uncomfortable then you would be conservative to moderate on risk tolerance. If you would not be comfortable with anything more than a couple percent drop in one month then you would be highly conservative. In contrary, if it would take a drop of 20% or more within one in order for you to become uncomfortable then you would be aggressive.

Remember, risk and returns go hand in hand. In general, you can expect higher return investments to have higher risk. This is because risk is not only about losing money. Risk involves the amount of deviation or fluctuation from the mean both up and down. As an example if you have the goal of 100% returns in one year, you may place yourself as high risk tolerant, but at the same time if would only be comfortable with a 2% drop in one month then you would have to choose which is more important and meet in the middle, accept lower returns for more comfort. In this example, you would have to have moderate risk tolerance.

Would you sell out or would you let your money ride? If you have a low tolerance for risk, you would want to sell out… if you have a high tolerance, you would let your money ride and see what happens. This is not based on what your financial goals are. This tolerance is based on how you feel about your money!

In the end it is goals, goals, goals and a complete understanding of what it takes to achieve those goals that will determine your risk tolerance.

Again, a good financial planner or stock broker should help you determine the level of risk that you are comfortable with, and help you choose your investments accordingly.