Identifying Your Risk Tolerance
While all investing involves risk, risk shouldn’t mean that you have to feel anxious or uncomfortable. You just need to figure out the level of risk that’s right for you.
Life is about trade-offs, and so is investing. The investment trade-off is between risk and return. Getting a return on an investment means accepting risk, at least to some extent.
But what, exactly, is risk? And how much of it can you tolerate? To start finding the answers to these questions, let's take a quick look at some key definitions.
- Risk – the probability that the value of an investment may go up or down.
- Risk Tolerance – your ability to handle fluctuations in the market value of your portfolio and your level of comfort with the portfolio's risk
When we talk about the concept of risk, we're focusing on both the possibility that you may lose some money and how comfortable you feel with that possibility. That second part—your comfort level—plays a big role in determining your risk tolerance. Accepting large amounts of risk may not be worth it if your riskiness is keeping you up at night. This is a decision that only you can make, and your decision won't align with all the other investors. Some investors may be comfortable with more risk than other investors even if they share the same goals and time horizon.