Tap below to watch a short video about investment risk tolerance, and read on for more details.
Risk tolerance is the degree to which an investor is comfortable and willing to make risky investments. Usually gauged by a calculator or questionnaire, financial planners often use risk tolerance to categorize investors and investing styles as aggressive, moderate or conservative.
The investor’s financial situation is perhaps the most important aspect to consider when determining risk tolerance. This is where net worth and risk capital come in.
Net worth measures the monetary value of an individual and is the maximum amount that can be invested.
Risk capital is the amount that an individual can afford to lose if the investment happens to go bad.
HOW TO APPLY NET WORTH AND RISK CAPITAL
Understanding net worth and risk capital can help you get a feel for whether you ought to be risk-averse or risk-tolerant. Here's how to use them to determine your ability to tolerate risk:
If your net worth and risk capital are low, then it would make more sense to be risk-averse (investing conservatively) and invest in low-risk stocks.
If your net worth and risk capital are high, you can be risk–tolerant, choosing high-risk stocks.
Investment goals also play a role in your investment strategy. Do you need this money now? Or can you let it sit for a while without withdrawing? This decision should be factored in as well.
At the end of the day, an honest understanding of your risk tolerance will allow you to make smarter, safer investments in a market filled with risk and uncertainty.
"Risk comes from not knowing what you're doing." - Warren Buffett