Risk Tolerance 101

How do we know how much risk we can stomach? One way is to test ourselves. For instance, I know I don't want to bungee jump because I've been on a roller coaster and it was too much for me.

risk tolerance, investing, investment advice, asset allocation, financial planning, financial planner

To some investors, that roller coaster was the 2008 financial crisis and it scared them silly. For younger investors, newer to the stock market, that roller coaster was March-April 2020. If they thought they were tolerant of losing money before, their theory was put to the test.

Some investors stuck to their plan and waited it out, in which case their patience was richly rewarded. Others were concerned that the beginning of Covid would bring our thriving economy to its knees and they decided to pull the emergency brake.

Whichever side you landed on isn't important, it's what you learned about yourself in the process that will help you define your risk tolerance going forward.

(This quiz from Vanguard is a helpful tool if you don't want to endure the real life consequences of the aforementioned risk exercise).

One sure fire way to buffer your investment portfolio from erratic swings is diversification. A well-diversified portfolio can weather a rough market better than a concentrated portfolio. It's simple to build a diversified portfolio with 4-6 low-cost ETFs or index funds.

These funds can be a mix of domestic and international stock, corporate and government bonds, real estate and commodities. You should never feel compelled to hold more stock than you can tolerate because the risk is a bumpy market will cause you to sell your stock in a panic rather than holding out until the market stabilizes which will result in more losses in the long run.

Working with a financial planner to build an investment plan that reflects your tolerance for risk and your long term goals will ensure you don't panic and you feel confident sticking to the plan despite market gyrations.


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