When looking to invest for the first time, it is important to understand what you want to invest, where you need to invest it, when to invest it, and why you are investing it. The first subject you want to consider when assessing your risk tolerance is what goals you have in mind for your investments. The second subject you want to consider is your risk personality to help determine the level of comfort you have with varying degrees of risk.
Creating Your Goals
An eighty year-old person looking to stabilize his/her investments versus a twenty-two year-old who is just starting his/her career will certainly have different levels of risk they are willing to take. The eighty year-old is looking to make low-risk investments that will probably earn a much lower interest rate, say of one or two percent, while the twenty-two year old is earning his/her full living from the job he/she has. The twenty-two year old may be willing to invest a large chunk of his/her savings with a higher interest rate that is more risky, because he/she does not need the principal nor the interest for a long time.
Knowing your financial position will help you to make a sound financial strategy and list of investment goals. If you are a billionaire, who makes $5 billion annually, you may choose to invest $3 million in the blink of an eye without much thought to it. This objective is vastly different than, let’s say, newlyweds who are looking to save for their first house. The billionaire might decide to invest in a risky real estate investment, while the newlyweds might decide to invest in bonds or CDs. Identifying your goals will become clearer for you once you understand your investment personality.
Assessing Your Risk Personality
One’s investment personality is defined by two specific character traits. One is simply how daring and risky are you, while the other is about how much time and effort you’re willing to invest into researching before deciding on a particular investment.
Risk is defined by the possibility of loss on your investments. The rewards you might receive are defined by the possibility of earning greater returns than you invested. If you are the kind of person who likes to live life on the edge, experience new adventures constantly, and have great confidence in your decisions and thoughts, then you might be willing to take on higher-risk investments. If you, on the contrary, are the kind of person who likes to make sure you are stable, secure, and have low worry/stress, then you may want to make an investment that is lower risk, which unfortunately has lower immediate rewards. This decision is extremely personal and can only be determined by you. Here are a handful of risk factors you should take into consideration:
- “Market risk,…
- “Business risk,…
- “Political risk,…
- “Currency risk,… [and]
- “Concentration risk.”
If you are unsure as to how risky you are, take this risk tolerance quiz.
Are you afraid of getting your hands dirty just yet? Try this free investment simulator, provided by Investopedia, to see how you would do if you had $100,000 to invest!
Come back in a few weeks to see the next installation of “The Beginner’s Guide to Investing!”