All investments come with a level of risk, whether you are investing in Government Bonds, the stock market or real estate. Risk in a financial context is the exposure to losses that you face when investing. Typically taking on a higher level of risk is rewarded with the potential for higher returns and determining an appropriate level of risk that suits you is an essential part of creating your investment portfolio. Whether you are an institutional level trader or simply wanting to experience the thrill of the stock market, the level of risk that you are comfortable taking will have a large impact on your portfolio management. Here are five things to consider when assessing your risk profile:
The time horizon that you have on your investment will determine a lot about the types of investments you make. If you are making an investment for your future in the form of retirement savings and you are still relatively young, you will be able to take a reduced amount of risk that will compound over many years. If, however, you need to make money in a shorter time frame, then a higher level of risk will likely be needed. A longer time horizon can also be useful to ride out any short-term market movements. There is potential for an investment to dip in value temporarily but recover in the long-run, a longer horizon will allow you to avoid these losses, whereas with a shorter-term investment you may be forced to take those losses.
Another important factor to consider is how much money you can afford to lose. This may sound pessimistic, but it is not wise to invest money that you may need at short notice. As all investments take on at least some risk you should be prepared to take some losses, should things not work out in your favour. Given you invest wisely these losses can be temporary and your investment may recover in due time. You will also want to consider how important these investments are to your future financial well-being, if the investment doesnt work out you want to know that you wont be in financial turmoil. If they are a make or break for you then a lower risk level would be more appropriate, but would likely come with a lower level of returns.
The amount of income that you will be receiving over the duration of this investment will also contribute to which type of investment you choose. You should look to be able to cover all your monthly costs and have some money left over for incidentals. This will allow you to leave your investment alone and not have to sell-off anything prematurely to cover short-term costs. Removing part of your investment will likely be very detrimental to your future gains, especially in the long-run.
Goals of an investment can range from keeping ahead of inflation to forming the basis of an income. This will consist of a dollar value that you want to aim for and a timeframe in which you want to achieve this in. Depending on your goal and timeframe, you will need to adjust the aggressiveness of your investment. Measuring the average returns per year you will need to reach your goal will give you an idea of how you will need to arrange your portfolio.
One final thing to consider is not a matter of finance, but rather a personal choice about how comfortable you feel in potentially losing money. This can be dictated by past experiences or your general temperament. Everyone will feel differently about taking on risk, and understanding how comfortable you are can help you with your investment. Remember, most people will feel losses much more harshly than the benefit they will feel from an equal amount of gains. With this in mind, it is important to know how much loss you can handle in order to pursue the potential for future gains.
Once you have an idea of the kind of risk level that you are comfortable with, you can begin to plan an outline of what kinds of investments you want to make. Completing thorough research about each of your potential investments is essential and the more of an understanding you have of your investment the better you can manage the losses and even prevent them in some cases.