Every in
vestor fears losing money but if you panic when there’s an unexpected drop in the market or a minor recession and throw away your carefully crafted financial plan, you can be certain of one thing: Your risk profile isn’t right. Of course, investing is about picking securities that will make money – and it’s also about choosing investments in line with your risk tolerance. Determining your risk tolerance can be difficult but when you get it right, investing will be that much easier. Here’s how.
Start with your goals You need to know what you’re trying to achieve before you can set your asset mix – in other words, define your financial goals. Age is also a factor. A younger investor with a long-term time horizon may choose less conservative investments while an investor heading for retirement may be more conservative.
Understand real market risk You may feel riskier than you really are when the stock market is producing spectacular gains. But when you experience an episode of market volatility, you may realize you aren’t really as risk-tolerant as you thought. Some investors can absorb a 20% loss a year and feel comfortable because they know that markets will eventually recover and rise. Others may panic and sell at a loss.
Define your risk tolerance The first step is to define your time horizon – is it short-term or long-term? Then define your true comfort level with risk by asking yourself how much you’re comfortable potentially losing in the short term. Don’t just use percentages – “I’d be okay with losing 10% or 15%.” — use dollar terms — “If I have X amount invested, I will be comfortable losing Y amount.” By establishing your correct expectations from day one, you won’t panic with inevitable market volatility. Your professional advisor will have a questionnaire to help you achieve the correct risk profile and investment mix for your situation. Talk to your advisor about your tolerance for risk and your overall financial plan soon.
