Knowing your risk tolerance is an important factor in investing. Some investors are willing to take big risks with the potential for big rewards. Others prefer to minimize their losses, even if it means smaller returns.
Determining what type of risk taker you are by taking our risk tolerance quiz can help you decide how best to invest your money. The stock market can be volatile, and the assets and allocations you choose should be those that make you feel comfortable personally and financially — especially for the inevitable dips in the market.
What Investment Risk Tolerance Is
When it comes to investing, understanding risk tolerance involves the following three factors:
• Your risk capacity: This is your ability to handle risk financially — the amount of money you can afford to lose without impacting your financial security. How close you are to retirement and the financial obligations you have will affect your risk capacity.
• Your needs and wants: These are your goals for your finances and your lifestyle. For instance, maybe you want to retire soon or save up for a down payment on a new house.
• Your emotional risk IQ: This is about your personality and how you see risk. You might be a thrillseeker who likes to live on the edge. Or perhaps you prefer a sure and steady approach.
💡 Quick Tip: Before opening an investment account, know your investment objectives, time horizon, and risk tolerance. These fundamentals will help keep your strategy on track and with the aim of meeting your goals.
Risk Tolerance Quiz
Take the risk tolerance quiz below to find out, then read on to learn about the best investment strategies for your investing style.
What Your Risk Tolerance Means
Now that you know whether your investment style is conservative, moderate, or aggressive, you can dig a little deeper to understand what’s driving your specific risk tolerance.
First, of course, there are the goals you’re saving and investing for. Is it retirement? A down payment on a new house? Sending your kids to college? Where your money is going will make you more or less willing to take risks for the potential of higher returns.
Your time-frame is another major factor. If you plan to retire in a few years, you have less time to recover from possible losses, so you’ll likely take a conservative approach to investing. You need your money to be there so you’ll have income to live on in your golden years.
But if you’re a newbie investor in your 20s, you have decades ahead of you with plenty of time to recoup any losses. In that case, you may be more aggressive with your investments to try to maximize your returns. And if you fall someplace in the middle of these two groups, time-wise, you might favor a more moderate investing strategy that balances risk and reward.
Your income is also very important. If you expect your income to grow, you may feel freer to take risks. But if your income is uncertain — maybe you’re a freelancer, for instance — or you don’t anticipate your salary to grow, you might be much more cautious with your money.
Finally, there’s your temperament. If you invest in stocks, for example, are you going to be filled with anxiety every time the market dips? Or are you more or less unflustered by swings in the market?
Thinking about these different factors can give you some insights into your feelings about money.
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Finding Investments That Match Your Risk Tolerance
With this new knowledge in hand, you can invest your money in a way that makes sense for you and the amount of risk you feel comfortable with. These are some scenarios you might want to think about, depending on your investment style.
• Conservative: A conservative investor may opt for a portfolio that mainly consists of funds that tend to be stable and lower risk, such as money market funds and government bonds.
• Moderate: An investor who takes moderate risks might choose to balance their portfolio between riskier assets like stocks and more stable investments like money market funds and bonds.
• Aggressive: This type of investor will likely gravitate to assets with a high potential for return, but also a higher potential for volatility and loss, such as growth stocks and options trading.
Whatever your risk tolerance is, it’s wise to diversify your portfolio across different asset classes including stocks, bonds, and commodities.
The Takeaway
Each investor has a risk tolerance level depending on their individual circumstances. A risk tolerance quiz can help you evaluate how much risk you should take.
That said, it’s vital to know that all investments come with some degree of risk. A conservative investor will likely feel better with lower risk investments, while an aggressive investor will typically look for assets with high growth potential, despite the higher risk they pose.
Once you have investments that suit your style and temperament, the better you may feel about your investment strategy. Just be sure to check your investments regularly to make sure they’re on target to get you where you need to be to meet your financial goals.
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