When asked about my personal risk tolerance I go first to my emotional risk tolerance. When I invest in something too risky for my emotions it makes life unbearable. An example is gambling, I cannot risk a penny on it. I get no pleasure gambling and the odds are I will lose to the house. I can, however, invest in the stock market because the odds are not stacked in favor of the house and I can see a benefit to society from growing healthy companies.
The second type of risk tolerance is impacted by time. Since higher risk is tied to higher return, you are forced to take greater risk to achieve a stated goal based on a shorter time frame.
You have a risk tolerance that should not be ignored. Any good financial planner or money coach knows this, and they should make the effort to help you determine what your risk tolerance is and how to manage it. They should work with you to develop a plan that does not exceed your managed risk tolerance. Your plan should include strategies that are structured to manage your emotional risk tolerance when riskier investments are needed to meet your goals.
Determining your risk tolerance involves several different things. First, you need to know how much money you have to invest, what your financial goals are and how much time you have to achieve those goals.
For instance, if you plan to retire in ten years, and you’ve not saved a single penny towards that end, your plan will require you to make high-risk investments – because you will need to do some aggressive – risky – investing in order to reach your financial goal.
On the other side of the coin, if you are in your early twenties and you want to start investing for your retirement, your planned risk requirement will be low. You can afford to watch your money grow slowly over time.
Realize of course, that your financial plan need for a high-risk tolerance or need for a low-risk tolerance really has no bearing on how you feel about risk. Again, there is a lot in determining your financial plan strategies. Find strategies that can help you deal with how you feel about your plan risk requirements.
For instance, if you invested in the stock market and you watched the movement of that stock daily and saw that it was dropping slightly, what would you do?
Would you sell out or would you let your money ride? If you have a low tolerance for risk, you would want to sell out… if you have a high tolerance, you would let your money ride and see what happens. This is not based on what your financial goals are. This watching activity is based on how you feel about your money! A better strategy might be to have a money coach help with the decision or limit the times you check on your investments.
Again, a good financial planner or money coach should help you determine the level of risk that you are comfortable with, and help you choose your investments and strategies accordingly.
Your financial plan should be based on what your financial goals are and strategies to manage how you feel about the possibility of losing your money. It’s all tied in together.