Risk tolerance. You’ve probably heard those words bandied about when talk turns to investing. But do you know what they mean?
Risk tolerance is generally defined as the ability to stomach large swings in the value of your investment portfolio. Because the market, by nature, is very volatile, understanding your risk tolerance is vital for making prudent decisions.
There are 3 factors to help you figure it out.
The first factor is time. When will you need the money? Generally, you can take a lot more risk if you’ve got 10-years or more. Money you need in the next 3-5 years should all be in cash. You don’t want to be forced to sell if the market is down.
The second factor is cash reserves. How much cash do you have on hand? If all your money is fully invested, with no extra cash to cover unexpected expenses or emergencies, that would pose a problem, especially if you have to sell when the market is down.
The third factor is sleep. How much volatility can you stand before you start stressing out, unable to sleep at night? We all know what happens if we don’t get enough shut-eye. Everyone suffers!
Those factors are crucial considerations. But in the end, risk is like spicy food…you don’t really know how much you can tolerate until you’ve tasted it.
Are there other ways you assess your own risk tolerance? Leave me a comment below.