The Gut Test: Determining Your Level of Risk Tolerance
While there are a variety of risk tolerance calculators out there, it’s worth noting that many of them are offered by investment & finance-related firms.
I do find the calculators helpful because they give an idea of the kinds of things to take into consideration, but for me, the best way to determine my level of risk tolerance is to listen to my gut. It probably helps that I lived through Black Monday (the “second-largest one-day percentage decline in stock market history”, according to Wikipedia) and I know that my reaction at the time was “well, this is pretty bad, but I’m in it for the very long haul and things should improve.”
Despite that (or possibly because of that) I’m pretty conservative when it comes to money. While I may be able to be philosophical about losses, I certainly don’t enjoy them. And I’ve seen just exactly how long it can take to recover from them. Other than those funds and a couple of real estate investments, I’m just getting started with actively investing. I plan to reduce risk by spreading it around. I’ve begun by starting with the dollar amount that I’m about to invest, and asking myself how I’d feel if I lost it all. How much would it upset me? Can I afford to do so? How likely is it to happen? How long would it take me to recover financially? And it’s mostly my gut that answers.
Amateur investors (most of us) buy high and sell low because we allow emotion to control us, both when buying and when selling.
Controlling risk involves picking investments thru diversification that will keep us from panicking when the market is dropping and give us courage to continue investing.
The suggestion that young people should be 100% in stocks ignores human behavior. I encourage all of my students to pick a balanced portfolio that smoothes out the highs and lows and allows them to control their fear of market crashes as well as get-rich-quick stocks.
Buying low and selling high is easy to say and almost impossible to do because of our emotions. To become a successful investor, diversify so you can sleep at night.
I suggest Scott Burns Couch Potato Portfolios but remember, KISS. If you do not want to spend your life monitoring investments, keep it simple.