Risk and potential return of your investments go hand in hand. The riskier an investment, the greater the potential for higher returns. Unfortunately, the potential for larger losses is also higher. Before you invest, you need to determine how much risk you are comfortable having in your investment portfolio. Think about the following questions:
- How much uncertainty in the potential return of your portfolio are you willing to take?
- How much of the money you invest are you willing to risk for the potential of earning better results?
Your answer to these questions is individual to you and can vary depending on your stage of life or the investment you are considering. Your capacity to take on risk is dependent upon:
- Your investment timeline,
- How much you already have saved,
- Your salary,
- Your pension and Social Security benefits, and
- The needs of your family.
Your personal risk tolerance is the amount of risk you can handle. Personal risk tolerance runs on a spectrum from being very risk-averse to risk-seeking.
- Very risk-averse investors prefer safe investments where the loss of principal is relatively small and the earnings are low and steady. A very risk-averse investor tends to check the investment value frequently and worry over small losses and be joyful about small gains.
- As risk aversion decreases, an investor is willing to take on more risk. He or she makes an investment choice, pays attention to what is going on, and rebalances when needed, but tends to be better able to ride the daily ups and downs in value without getting overly stressed or joyous.
- Risk-seeking investors are the most aggressive and actively seek out risky investments in chase of the big return.