One of the biggest parts of investing is determining your own risk tolerance. When most people think of risk tolerance, they think, “How much can I stand to lose before I start to struggle.” Risk is a huge part of investing because it dictates what sort of mutual funds you can put your money into, how much money you can invest and for how long. Knowing your risk tolerance is one of the biggest keys to successful investing.
Risk is usually defined as short term volatility in prices or variability in prices. But there is a whole other kind of risk at the other end of the spectrum. The risk of not meeting your goals by investing. The main reason why anyone begins to invest is to meet goals that they have set for themselves. The most common goal in investing is saving money for retirement or for that second home. Risk goes both ways, there is the chance you could lose your shirt with an investment, and the chance that if you don’t take enough risks, you won’t meet the goals you’ve set for yourself.
The first thing you need to do is to take a personal assessment of your own risk and develop what is known as an investment personality. Everyone’s personality will be different, they are unique like fingerprints. Some investors can stand to take some big chances now with the lure of a potential payoff down the road, while others who may not have much time between the time they start investing and the point where their financial goals need to be realized and can’t take big risks.
A good barometer to judge your risk is how will you feel if your capital goes up, down or stays the same? Are you willing to be patient and accept small increases, or do you want to see the most possible movement? If you’re sitting at your computer right now ringing your hands in fear that you might lose money on your investment, you should already be able to tell exactly what sort of investor you are.
Assessing both ends of your risk tolerance is quite possibly the most important single financial decision you can make. Knowing how much money you can invest, how long you need to invest it for and what kind of mutual funds you want to buy into is very important. Once you determine your own risk tolerance, you will be ready to take the next step and start investing.