Risk Tolerance Breakdown

What is Risk Tolerance?

What is risk tolerance? Simply put, risk tolerance is the level of risk an investor is willing to take. But being able to accurately gauge your appetite for risk can be tricky. Risk can mean opportunity, excitement or a shot at big gains—a “you have to be in it to win it” mindset. – Charles Schwab

When it comes to investing, most people do not understand what their risk tolerance is. It is easy to get swept up in the investing fever that grips people after watching a movie. You see the actor making all this money and you think you can to. Well, you can, if you do it right. Investing comes with a lot of challenges and risk, understanding and educating yourself is important. Figuring out how much risk you are willing to take comes down to a few factors:

• Age
• Income
• Investment Time Frame
• Volatility Comfort

By understanding the above, you can better make choices in the market. I for one made a few mistakes my first go around but those lessons were important because they helped me become a better investor. I am proud to say I do not make mistakes as I did before. I take my time, research the company and decide based on my strategy.

Let us break down the above.

Age

Age plays an important in this equation. The younger you are when you start, the more calculated risks you can take. The upside to this is you can play around and figure out your investment strategy. And when the market takes a hit, you have time to make it back up.

As you near retirement, the risk you want to take should be minimal. A wrong move could set you back or worse.

Income

Income isn’t important if you are young. Any job will do as long as you are heavily investing. As you get older you will want a job that is stable and can support you, your home, your family and your investment strategy.

The goal with this is to build enough passive income by investing your earned income, so you can retire early or on time.

Investment Time Frame

A major problem that most people do not realize when they are young is that retirement is not far away. It may seem like a million miles away at 16 or 18, but life has a way of creeping up on you. Before you know it you are 62 and panicking because you do not have enough.

Figuring out when you will need the money you invested is important. The more time you have to invest, the more time you can focus on aggressive investments that have more growth potential. However, let us know disregard safe stocks that grow slower but have a more stable growth and dividend payout.

Comfort with Volatility

This is another big one in this list. When it comes to investing, it is easy to get wrapped up with the ups and downs of the market. You need to be comfortable seeing red some days and green the next. This is part of the road you are going down and something you need to be ok with.

Educating yourself goes a long way with reducing your risk paranoia. If you can’t sleep at night because of your stocks, you either have anxiety or do not know enough about investing. I can’t fix the anxiety part but the education part is easily fixable.

I for one love when I see red because that means I can buy the stocks I am investing in cheaper. For me, this is good because I am trying to reduce my overall buy price and increase my profit for that share I am buying.  Over time you will come to see this benefit as well. Especially if you are a dividend investor because whether it is red or green, you are still being paid. Research and educate yourself and I promise you’ll become comfortable with the market’s volatility.

• There are a few ways to reduce your risks in the market.
• Sector diversification (Own shares in different sectors)
• Market-Cap Diversification (Different sized companies)
• Asset Diversification (Bonds or real estate)

The more you diversify, the less chance of a major downturn happening in your portfolio. If one sector takes a hit, the others will keep your portfolio up. The downside to this is, the safer the portfolio, the less gains you will see. The goal is to find a balance based on your age and time frame.