Your Risk Tolerance
May 24, 2012 § Leave a comment
It feels so good when the stock market goes up. Not so good when it goes down. And for some of us, we feel a little icky when it ricochets up and down and up and down. Maybe it would be better if you invested for your unique risk tolerance. And though there are several components to investing, knowing your risk tolerance is key.
Your risk tolerance– Gauged generally with a questionnaire, risk tolerance measures how you would feel in the ups and downs of stock market movement. Generally we all want our money to go up, but are less inclined to have it go down. Risk tolerance is not an exact science. There is no Vulcan Mind-meld that can ascertain your tolerance.
So a questionnaire is often used to get as good an idea of what mix of investments may work best for you. The questionnaires use hypothetical situations and other things, perhaps age and the money’s use, to come up with your general risk category.
Once determined, along with your goals, tax status, etc., your risk tolerance helps you or an advisor compile what mix of investment types you might hold, i.e., what your ‘portfolio’ might comprise be it all stocks, all bonds or a mix of stock and bonds. And depending on whom you ask, there are just a few, or many categories of risk. As I said, this is not an exact science.
What is risk?– In life risk is the possibility that things will go wrong. In finance risk is the possibility things will go wrong and negatively affect your investments. As you may have realized, life has no guarantees. So the more you learn and the more of life and investing you experience, you may find our risk tolerance change. If you have no knowledge and little experience, it’s is not unexpected that you would be a more conservative investor. You may always be conservative in your investing because that is your nature, but you may also move into a slightly more aggressive category of risk because you feel more confident and knowledgable.
Even with fear or optimism, you sometimes have flexibility in your risk tolerance. You can take some more risk and be within your tolerance, when you feel more comfortable with the investment, the holdings, the companies in which you are investing. You may have more capacity for risk- meaning being able to accept more or less risk- when you are investing in things you understand more than just when you have a vague idea of something called the ‘stock market.’
For instance if you understood one mutual fund held companies that manufacture and distribute cat food, ice cream, or held companies that own chain coffee shops and other companies providing products or services that are explained to you and that you perhaps frequented, you may find that you have the risk capacity to invest in such a fund.
Educate yourself– One study by Fidelity investments found that younger investors were as conservative as their Baby Boomer counterparts. because they all considered themselves ‘beginner investors.’ A spokesperson for Fidelity states in the same survey that ‘time is one of the biggest factors when determining asset allocation.’ I don’t know that I agree that time is the biggest factor in asset allocation. I think it’s an obviously important factor. But I think your risk tolerance is more a part of who you are as an individual and that time, your goals and personal circumstances all add in to the mix of variables that help tweak your unique risk tolerance.
Certain times in your life may have changing personal circumstances. In those days you feel more risk averse, or more open to risk. Just remember, risk tolerance is important but that this is not an exact science.