What is Your Risk Tolerance?

Risk tolerance is a measure of your ability to handle or embrace risk. In the world of investing, as in other areas of endeavor, the higher the risk, the higher the return. However, you have to determine what level of risk you can handle.

Your risk tolerance is a factor in your age, temperament, financial literacy, financial state, and goals. Each plays a role in how much risk you can handle.

Age
The closer you are to retirement, the lesser the risk you can take. By the time all you have is your gratuity (last card) and pension, you are in a very vulnerable position, and if you take a wrong step, you pay dearly for the rest of your life. At a younger age, time is on your side to recover from financial mishaps.

Temperament
Some folks are naturally bolder than others and may attempt to thread where angels dread. Many have a morbid fear of failure, hence are frozen into inaction while the more adventurous type know that you miss 100% of the shots you don’t take, so they improve their odds at succeeding by making an attempt, knowing fully well that failure is part of the process to success.

Financial Literacy

The more knowledgeable you are on any subject, including investing, the less risky it becomes. If you go in green, you are gambling. Rich Dad believes there are no risky investments, but risky investors. One investor’s jackpot can be another’s Waterloo. The difference is in financial literacy.

Financial State
If you have no savings and decide to invest in your children’s school fees, you are heading for heartbreak. There are investments that have guaranteed returns, e.g. fixed deposits, bonds, treasury bills, etc. However, these are low-risk low returns investments. If you want to join in the investments of the rich, you have to be armed with money you can afford to lose. Where your investment is at risk, you need the financial muscle to withstand possible upsets. Hence your financial state determines your ability to take risks.

Goals
If you have no plans to retire young and retire rich, you will make do with low-risk low returns investments. If you have an aggressive plan for an early exit from the rat race, you have no choice but to step up your game in the risk department. The nature of your financial goals determines the level of returns on investment required to achieve it. The higher the required returns, the higher the risk you need to take.

Before you venture into any investment, you have to do a reality check on your risk tolerance, and only undertake risks you can handle. In a bid to achieve high returns, you have to ensure that your assets base is secure, through smart asset allocation, so that an upset in one sector does not throw you into a financial crisis. A plan to be rich includes a plan to be secure and a plan to be comfortable. If you go for riches without first becoming secure and comfortable, if your plan backfires, you will find yourself back in the streets.