Do you know your risk tolerance when it comes to investing? Do you understand the importance of risks in building an income generating portfolio? Can you watch your investments turn bloody red but still be able to sit back, relax and still feel confident about your investments while losing a lot of value? If you don’t know what risk tolerance is, then you should stop investing for now and distinguish the level of your risk tolerance.
What is risk tolerance?
So what’s precisely is risk tolerance anyway? Risk tolerance is your power or lack thereof, to take a big loss. So if you wish to earn 10% on your investments, you also should be willing to lose 10% if something goes bad. This risk tolerance should be decided before you start investing. Depending on your risk tolerance, you may ride out the waves of the stock market and hope to regain your 10% loss if you’re a long-term investor. But if you’re a short-term investor who needs the money to pay off something important on a defined day; a college tuition perhaps, then you would be in a financial disaster.
So how do you determine your risk tolerance?
Risk tolerance can be determined through certain factors like you age, your present income, your financial goals and your emotional behavior. An investor who’s incapable in taking many risks is said to be a risk-averse person. A risk-averse person should consider investments with lesser risks; like retail treasury bonds, certificate of deposits or a savings account. These investments provide low rate of returns but the thing is, it will let you sleep well at night without worrying too much about it. On the other hand, an investor who likes taking risks is said to be a risk-tolerant individual. A risk-tolerant investor is more likely to invest in stocks where the risk-return trade-off is high.
It is also important to know your risk tolerance in comparison with your financial state during the duration of your investing career. It is because as your financial state changes, so does your risk tolerance. In order to have a good income generating portfolio, you have to be flexible and adaptable to the changing conditions everyday.
Conclusion
When you decide to invest in the stock market, you have to define your investment goals and objectives. You have to define why you will be investing; for what purpose and objective, and then set the length of time of your investment plan. After that, define your acceptable risk for return and find a suitable investment vehicle where to put your money in.
Happy investing!