When the topic of investing comes up, most people want to simply talk about how much money they have made from their investments. But let’s be real for a second. Not everyone will have the same results. Some people will make more and some people will make less. And that is in part due to the different mutual funds, stocks, bonds, etc. that you can invest in. But it is due more to your comfort level with risk. The official phrase is risk tolerance. Let me explain.
(1) Risk Tolerance: More Risk-More Reward; Less Risk-Less Reward
This is one of the most basic fundamentals of investing. In order to make money you have to risk some money. There is no way around it. There are no zero-risk investments that you will get a large gain from.
So from that we can conclude that if you risk more, you have the possibility for more reward.
And if you risk less, you have the likelihood of a smaller reward.
The two go hand in hand. Learn how risk and reward go together here.
In order to understand your own risk tolerance, you have to first understand that there is a direct relationship with risk and reward.
(2) Risk Tolerance: Not Everyone’s is the Same
This is the main point of this article. Not everyone’s risk tolerance is the same.
Just like there are people who think that pineapple goes on pizza and there are other people who think that the pineapple pizza people can go to Hell, there are many appetites for investing as well.
Let’s stick with the food analogy.
Some people like spicy food and some don’t. Of those of us who like spicy foods, there is a WIDE berth of people on that spectrum. Some people can only handle a jalapeno popper or two while other people will eat carolina reapers for breakfast. And of course, there are many people in between.
When investing, some people want more spice (risk) in their investments than others.
Some people like to eat a Carolina reaper just like some people like investing in small tech startups.
Other people might just like to have one jalapeno popper just like some people want to invest only in low risk bonds.
(3) Risk Tolerance: It’s Okay to be Different
Everyone will have a different risk tolerance, and that is okay!
Why is that okay? Two reasons:
- There are billions of people on this planet and we are all a little different.
- We all have different goals that require different levels of risk.
We’ve already talked about #1 quite a bit so let’s talk about #2.
Typically, as people age their risk tolerance goes down. Why? Because when you have more risk, there is a greater chance of loss. When you are 25 and have 40 years until retirement and you have a loss in your portfolio, that’s okay because you have four decades to recover.
But if you are 63, you don’t want a big loss in your portfolio because you will need that money much sooner. Therefore, you will want to take on less risk than the 25-year-old counterpart.
Even between two 25 year old investors who both have the same amount of time until retirement, they each will probably have a different risk tolerance.
On a scale of 1-100 (1 being low risk and 100 being high risk), the first 25-year-old might want risk to be at a 90 while the second one might be more comfortable with a 35.
This isn’t a problem at all. There is no one-size-fits-all approach to investing. All of us will have a different risk tolerance.
It’s important to know yours.
There are several online risk tolerance questionnaires to help you assess how much risk you should be taking but this one is my favorite.
Final Thoughts
Risk tolerance is something that we should all have a good idea about if we are going to invest money. We need to understand how much risk we are taking (or not taking) based on our personalities.
You probably won’t have the same risk tolerance as your friend or even your spouse either. A good financial advisor will make sure that you have your money invested in risk-appropriate investments.
I’m so happy you’re here!
You can do this!
Until next time!
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