What Exactly Is Risk Tolerance?

By Forge Financial Freedom on The Capital

Each investor has a risk tolerance and it shouldn’t be ignored.

Risk tolerance is the degree of volatility you can withstand in your investments.

A person with LOW risk tolerance will usually invest in “tried and true” companies with steady returns, nothing amazing but your money is growing.

A person with HIGH risk tolerance will invest in speculative things like tech stocks or cryptocurrencies. These kinds of investments can have a big payoff but they can also lead to huge losses.

Determining one’s risk tolerance involves several different things.

First, you need to know how much money you have to invest, and what your investment and financial goals are.

For instance, if you plan to retire in ten years, and you’ve not saved a single penny towards that end, you need to have a high-risk tolerance — because you will need to do some aggressive or “risky” investing in order to reach an amount of money that could support you in retirement.

This may sound like bad advice, but honestly, you don’t have much to lose at this point and a lot to potentially gain.

On the other side of the coin, if you are in your early twenties and you want to start investing for your retirement, your risk tolerance can be low. You can afford to watch your money grow slowly over time.

But let’s look at two different scenarios:

If you are young, you can also afford to make big risks with your investments because you have the time to make mistakes.

Maybe you should take big risks because you have decades of chances to win big.

High risk but possibly high profits.

Alternatively, if you are older and you’ve been diligently investing your whole life, this is no time to start going full Wolf Of Wall Street mode.

You already have a big pile of cash so just enjoy it in your golden years instead of risking it all.

Low is probably the way to go.

Realize of course, that your financial goals really have no bearing on how you feel about risk.

There are emotional factors in determining your tolerance.

For instance, if you invested in the stock market and you watched the movement of that stock daily and saw that it was dropping slightly, what would you do?

Would you sell your position or would you let your investment whether the storm?

If you have a low tolerance for risk, you might panic and feel like you need to sell away.

if you have a high tolerance, you would let your money ride and see what happens.

This choice had nothing to do with what your financial goals are.

This tolerance was based on how you feel about your money!

Your risk tolerance should be based on what your financial goals are AND how you feel about the possibility of losing your investments.

Emotions and logic are factored in together.

Risk tolerance should be looked at as your own personal view of money.

Is money something you can afford to play with or is it something you NEED to grow.

No one can tell you exactly how to invest (except a financial advisor) because your individual situation will be different.

Ask yourself, how much do you want your money to grow, how much time do you have to do it, and if you like sure bets or speculative bets.

Invest accordingly.

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