When it comes to investing, everyone has a different risk tolerance. Your co-worker or neighbor may not give a second thought to an investment that may keep you up at night. But risk tolerance isn’t a matter of “good or bad.” Whether you thrive on risks or avoid them at all costs, the important point is to know the level of risk that best suits you.
Investing typically involves a tradeoff between risk and return. Returns come in the form of interest, dividends and/or capital appreciation. Generally, the riskier an investment, the greater the potential return. This is because the market theoretically “rewards” investors for taking risk, which there is the possibility of a loss. Investors in pursuit of higher returns must be willing to assume the likelihood of loss associated with more volatile investments.
But not everyone wants to take a higher risk in the hope of achieving a larger return. Some investors are perfectly satisfied receiving smaller returns on investments and carry lower levels of risk. The key is to find the right level of risk that potentially allows you to achieve your desired return, while keeping your stomach jitter-free!
What factors affect risk tolerance? Your age, stage in life, personal preference, financial goals, and time horizon all play a role. Here is a brief discussion of these points:
Age and Stage in Life. Generally, the younger you are, the more risk you can assume. If you are single, you may be able to allow more risk than a married couple with children. And, if you’re starting out in the work environment, you may be more comfortable with higher-risk investments than if you are closer to retirement.
Personal Preference. At every stage of your investing life, it is important to evaluate how well you would handle the possibility of losing any funds you invest. Though you may find a roller coaster ride thrilling, you may not enjoy a wild market “ride.” For instance, the stock market has historically risen over the long term, yet it has experienced wide short-term fluctuations. How well have you handled events when the stock market has dropped by more than 40%?
Financial Goals and Time Horizon. It’s also important to consider how many years you have to meet your financial goals. Generally, the earlier you begin saving, the more risk you may be able to assume. Though you should never take on more risk than you are comfortable with, you should also recognize that the amount of risk you are willing to carry affects the return you can expect to achieve.
Periodic Reviews—A Must
Knowing your “comfort level” for risk is a must when you make investment decisions. With proper planning, you can develop a portfolio that balances your risk tolerance with your financial goals. Since risk tolerance changes with time and circumstances, it’s also a good practice to review your investing strategies as you start a family, approach retirement, or experience other major life changes.
The information provided is for educational purposes and for your independent consideration. This information does not contain, constitute or provide individual tax, financial, or investment advice. This material should not be considered as a recommendation of any particular security, strategy or investment product or service. Particular investment or trading strategies should be evaluated relative to each individual’s objectives and risk tolerance. Readers are urged to seek professional advice with respect to their specific financial, legal, tax, and investment matters. Investment products are not insured by the FDIC, are not deposits or obligations of and are not guaranteed by Banco Popular de Puerto Rico or its subsidiaries or affiliates and may lose value.
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