You’ve witnessed your peers do it. You’ve watched your favorite influencers talk about it. You’ve even seen friends & family succeed at it. But you’re still afraid of it. What is it? Investing.
You’re not alone in thinking that way. For many, the thought of investing brings up bad feelings, with 65% of Americans saying they have regrets about an investing decision they made. Common regrets include selling a stock too early, taking money out of a retirement account too soon, ignoring investment advisors, misunderstanding one’s risk tolerance, and putting off investing entirely.
To start investing on the right foot, you should evaluate your risk tolerance level.
What is risk tolerance?
Risk tolerance is how much variability an investor is willing to accept in any investment. It is one’s financial and emotional ability to withstand any losses in investing. It depends on how much market risk the investor can tolerate, factoring in stock volatility, socio-economic and political events, and interest rate changes.
Once you recognize your risk tolerance, you can start planning how you want to invest.
Usually, aggressive investors, or those with high risk tolerance, can risk more money, so they are more likely to invest in equities and equity funds and exchange-traded funds (ETFs). They may be more open to illiquid investments that do not have as much short-term flexibility.
Meanwhile, those with lower tolerance can be classified as conservative investors, and their portfolio will include more low-risk investments, like government bonds. In terms of real estate, a conservative investor wants to focus on REITs that are conservatively leveraged (40-60% range).
How can you evaluate your risk tolerance?
How to determine your risk tolerance
There are several factors that typically affect risk tolerance, and they differ from one investor to another.
With age comes different life stages and goals you set yourself to accomplish. The ability to take risks also changes as you grow older. Younger people have the time and ability to work harder and earn more money, so they can take more risks compared to older folk who are already dependent on their retirement money.
This depends on your investment goals. In principle, more risk can be taken if there is more time. For instance, a young adult who is saving up for retirement has more time to ride out the market’s ups and downs. But for someone planning to buy a house in a few years, certain investments might be too risky, as there may not be enough time to recover.
The larger the portfolio, the more tolerant to risk an investor is. That is primarily because if the market drops, the investor with the larger and more diverse portfolio has more cushion to support the loss. Someone with a $5 million portfolio can take more risk than someone with just $50,000.
Personal preferences & beliefs
Investors handle risk differently, and this directly affects where you would place their money. Moreover, researchers found that loss aversion, or the fear of losing money, is an accurate indicator of risk tolerance. Therefore, those who fear losing their money in market volatility will just go for low-risk and short-term investments.
Your investment portfolio is a reflection of yourself
With so many options for investment potentially leading to success or failure today, it’s worth turning to a financial professional who can guide you through the process of understanding both yourself and the market. If you want to learn more about investments yourself, then learning platforms like Coursera and EdX can also help give you a great foundation for working with a professional — and eventually succeeding as an investor.
Investing is a personal choice, as your methods reflect who you are. As mentioned in a previous post, your investment portfolio is a mirror. So don’t worry about other people’s sentiments and ways of investing, just evaluate what you have and take your next steps from there.
Interested in how money makes the world go round, Reese Jones is a finance and business blogger. She spends her free time watching documentaries and mastering the craft of photography.