One of the things that makes people fearful when it comes to investing is the idea of loss. Some people are more afraid of loss than others, and so they aren’t willing to risk very much. Others can handle the bigger losses. How much you risk you can stand — what you are willing to lose — is sometimes referred to as risk tolerance. And before you invest, it is important to take a look at your own risk tolerance.
Risk tolerance is more than just fear. It involves your financial as well as your emotional state. Indeed, you need to look at both financial and emotional factors before you can have an accurate picture of your risk tolerance.
Emotional risk tolerance
This is where the investing fear factor comes in. The question you have to ask yourself is this: How will investing affect my emotional state? Do you agonize constantly over your portfolio, checking your stock performance daily? (This, BTW, is not health investing behavior.) This has nothing to do with how much money you have, or whether you will be okay if a high-risk investment goes south. It has everything to do with whether or not, emotionally, you can stand the thought that you might lose.
Financial risk tolerance
This portion of the risk tolerance picture is much more straightforward. It’s all about the numbers. How much money do you have? If you lost on your investment, would you still be financially solvent? If you have more money, you can afford to lose more, and higher-risk investments won’t be as much of a problem. However, if a big loss in a risky investment would financially maim you, then you have a low risk tolerance, and should stick to lower-risk investments.
Building your risk tolerance
It is possible to overcome the investing fear factor when you know your risk tolerance and can build from there. Start with relatively safe investments, such as high yield savings and money market accounts, bonds and large-cap companies. Engage in dollar-cost averaging so that you aren’t putting large chunks of money in at once. As you start to see good results, and as you learn more about investing (and earn more money), your risk tolerance will go up.
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