Are lottery tickets a component of your retirement program? Then you sound like an extreme risk-taker when it comes to investing. Do you throw up every time you hear that the stock market dropped? Then odds are you are a conservative investor.
All kidding aside, it is wise to take time to seriously assess your own risk tolerance. Your investing strategy and retirement goals may not match up with your risk tolerance, especially if you started investing late. Keep in mind that greater rewards are almost always accompanied by greater risk. That doesn't mean, though, that you should take unnecessary risks, like investing with someone you just met at the gym.
It can be very difficult to see your own attitude toward risk objectively. If you have a trusted investment advisor, she or he can help you soberly assess your level of risk tolerance. Online risk assessment tools are another objective way to gain insight. Most investment websites have such tools that you can use for free. If you take several of them and get similar answers, you can feel reasonably confident the assessments are correct.
These assessment tools are generally going to be surveys or questions posing hypothetical situations that give them insight into your thought processes about money. Questions on these tools tend to cover some, if not all, of the categories below:
- Sure Things vs. Risk/Reward – The question may take the form of what you would prefer, 100% chance of a lower reward or some lower percentage chance of a higher reward. The intent is to determine how much reward it takes for you to assume a particular degree of risk.
- Gain/Loss Situations – You are confronted with a hypothetical windfall or loss, and given a series of options to choose from for your next move. The options range from conservative to risky. The goal is to learn about your ability to handle losses, and whether you handle them differently than gains.
- Assessing Investment Opportunities – You are given certain investment scenarios and asked to choose whether you would participate in the opportunity, and how much you would risk. There may be an estimated chance of success included.
- Self-Analysis – How do you describe your attitude toward risk, and how do you think others would describe your attitude toward risk? The two answers are not always the same. There may also be questions about your experience and comfort level with investing. Your self-analysis is then compared to your choices in the above situations. Do your perceptions of yourself match your preferred actions?
Your responses are put through an algorithm to determine your general risk tolerance, as well as specific aspects of your risk tolerance. For example, are you willing to take greater risks with windfalls or so-called "found money" then you are with your general investments? Do you have a low threshold of acceptable loss, and does that change based on the amount of possible reward?
If the assessment is through an investing website, they will probably suggest investment vehicles that are a good with fit your needs, at least with respect to risk. However, advice given by an online investment provider who stands to make money on your transactions should always be taken with at least a few grains of salt. You may prefer to seek the advice of an investment professional that you trust.
The main message is to know your risk tolerance, and evaluate it objectively. Then you can assess whether your risk tolerance contains adequate reward to meet your retirement goals. If not, you may need to develop a greater risk tolerance to meet your goals, or scale your goals back somewhat.
Brad is a Registered Representative with, and Securities and Advisory Services offered through LPL Financial, a registered investment advisor, Member FINRA/SIPC. CA Insurance License #: 0B22199.
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