Financial Tip Friday: What Is Your Risk Tolerance?

Financial Tip Friday: What Is Your Risk Tolerance?

So in several posts I have harped on the idea that everyone should invest as soon as they can. That could be in their 401k, Roth IRA, whatever. It isn’t that hard to open an account and you can start contributing right away. The question is what things should you invest in? How much do you want to put into stocks? bonds? commodities? real estate? What combination of these types of investments and more should you put together when trying to invest.

A key part of figuring out that question is what your risk tolerance is? In other words, does putting your money in the stock market keep you up at night? Are you afraid you are going to lose every dime? On the other hand, your attitude might be that you aren’t going to need this money for a long time who cares if the stock market goes up or down in the short-term. It will certainly be higher when I need the money later in life.

Your basic risk tolerance can really be a guide for much money you want to put into mutual funds or other investments that might have a higher risk (e.g. stock funds or commodities) but a greater return or lower risk investments (e.g. bonds) that are safer, but have a lower rate of return.

Your risk tolerance can depend on a number of factors. Your age might be one of them. The younger you are the more you might realize that you won’t need you investments for a long-time, like decades. However, if you are looking to retire in a short period of time (e.g. five years) you might want to have less exposure to “risky” investments. And if you do what is the combination of those investments.

Investment Rules of Thumb

When you answer the question about your risk tolerance for the stock market then you can make a more informed decision into what you want to invest. Do you want a larger portion of your investments in things that will bring higher risk, higher reward? Do you want less? What?

Supposedly, there are several rules of thumb people can use to make these kind of determinations. Typically, these rules of thumb involve a number minus your age.  One rule of thumb argues to start with the number 100 and subtract your age. So if you are 40 years old you would have 60% of your investments in stocks or mutual funds that emphasize stocks and 40% would go toward bonds or mutual funds that emphasize bonds. However, because people are living longer the 100 minus age rule is sort of outdated. Some people recommend that you take the number 110 or 120 minus your age to figure out your asset allocation.

For the purpose of full disclosure most of my investments are in stocks. In fact, my allocation is about 95% stock mutual funds and 5% bonds. I know it is on the riskier side of things, but I realize I won’t need that money for a long-time. Plus, I want greater returns on my investments. I don’t mind the volatility. In fact, the past week I have lost over $10,000 in my investments. While I don’t like to lose money my attitude is so what? This time next year I could be down $40,000 or more or I could be up? Ask me in 20 years then I will care more. Eventually, I will make my investment portfolio “less risky” by investing more in bonds, but for the moment my risk tolerance is pretty high.

The Bottom Line

Shakespeare wrote, “to thine own self be true.” That sentiment not only works for yourself, but for investing. There is nothing wrong with being a little scared in the stock market. I would much rather have someone put all of their money into bonds than hide it under their mattress. It is important to understand how to invest and knowing what your risk tolerance is with the stock market is part of that understanding. I don’t necessarily recommend that you have 95% of your investments in stocks like I do. But I do suggest that you begin investing, understanding what you could invest in, and then determining where you want to put your money. There is no right or wrong answer. The key part is to begin, learn, and take your next step in your financial journey.

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