Determining your Risk Tolerance

Determining your Risk Tolerance

Perhaps the most important factor in formulating your investment plan is your risk tolerance; this is the amount you’re willing to risk in order to achieve your most important financial goals. Essentially, we like to think that your risk tolerance is based on your financial and emotional abilities to withstand negative returns on your investment portfolio.

Before embarking on any investment planning in Fargo, ND (or anywhere for that matter), it is important to know your overall risk tolerance to ensure that you select the right kind of investments and you are able to set clear objectives. More importantly, you're assured many more restful nights when your investments are aligned and balanced properly. So, how do you go about determining your risk tolerance? 

Look at your Time Horizon

The most important determinant is time; this refers how much time you have before you will need to access the money being invested. Younger people, those with more than 30 years before retirement, are more able to withstand the swings and the cycles of the stock market because of the tendency for the market to (ideally) increase over time.

The Impact on your Current Financial Situation

When the stock market declines by 20% or more in one year, as it has done a few times over the last couple of decades, a younger investor, ideally, has the time to allow the market to recoup its losses and forge ahead for a couple of years. Therefore, a younger investor could potentially take a more aggressive posture towards investing by increasing their exposure to stocks.

An older investor with less than 15 years before retirement has less time, and therefore, fewer opportunities for the market to recover from multiple down years or extreme volatility. While it is still important for investors in the pre-retirement phase of life to maintain a growth orientation on their investments, their portfolios need to be stabilized with investments that produce less volatile, or more predictable returns.

 

Digging Deeper for Answers

You need to ask yourself some serious questions to determine your general attitude about risk: for instance, when you make decision about your money, such as making investment, borrowing money, or making a big purchase, do you usually feel  

A) Anxious
B) Satisfied
C) Hopeful
or D) Invigorated

Finally, your response to loss may be the most telling indicator of your tolerance for risk. Using the stock market crash of 2008 as recent point of reference, your response, either hypothetically or in reality based on your actual response, may say the most about your risk tolerance going forward. For instance: during the stock market crash of 2008, did you (or would you have)


A) Cashed out all of your equities
B) Reduce your equity exposure substantially
C) Hold firm to most of your equity positions
or D) Start adding to your equity positions

 

Thinking it over

It is very important to be mindful of the fact that your risk tolerance may evolve over time. This personal assessment should be conducted periodically to ensure that your current asset allocation reflects both your emotional and financial ability to tolerate risk. Most importantly, you should always speak with a qualified financial specialist when assessing your investment capabilities and options.

 

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