There are several types of “risk”: the risk of losing money, experiencing volatility, or missing out on return are some common ones. But understanding your risk tolerance is the most important.
With anything, there are no sure winners and no sure losers, especially in the short term. How comfortable you are with the latter statement may give you a clue as to your risk tolerance. You can think of your risk tolerance as how much uncertainty you can live with from day to day.
Do you watch the stock market daily or even hourly? If so, does it fill you with dread or excitement? These are the kinds of questions you should be asking yourself. The answers will help guide the decisions on how your investment portfolio should be constructed.
1. A Personality Test
The individual identity component of risk tolerance assessment is one of the most important. Some of your risk tolerance can be measured, such as factors like your age or your income. However, some components are more difficult to measure. Some individuals are risk takers and more comfortable with fluctuations, while others are risk adverse.
You may simply dislike any risk to your principal and that’s okay. You have to be comfortable with any degree of risk you take.
2. What are Your Financial Goals?
Do you save money to accumulate wealth or are you looking for ways to enhance your return? If your only goal is to have a nice pile of money to retire on when you’re 70, slow and steady is your investment pace. On the other hand, if you're looking for higher return on your money usually some degree of fluctuation is inherent. In the short term, you will experience tough markets and negative returns, however IF you can stay disciplined during tough markets, the longer term will offer you rewarding results.
Retirement-focused goals aren’t the only goals that can impact your investment strategy. You may be saving for a house or considering buying a business.
3. How Much Time Do You Need?
If you’re relatively young, you have plenty of time to ride out the peaks and valleys of economic cycles. You can tolerate a little more risk by design. If you have a goal you need to meet quickly (buying a home) or you are nearing retirement age, you may want to think more conservatively so that you don't risk your principal amount.
Preparing for cash flow needs is one of the most important considerations when determining your risk tolerance.
4. Your Wealth and Income
If you have $5 million to invest, you can take more chances with portions of your money than you should if you have $50,000. That’s fairly straightforward. You may also consider additional factors, such as the amount of debt you’re carrying, any fixed payments, and/or whether your personal ecosystem (job, family, assets, etc.) is strong and stable.
The worst position you can be in is needing to withdraw funds unexpectedly during an inopportune time. It’s best to err on the side of caution.
5. It's Not All of Nothing
Learning about your personality will help you make better decisions that impact your future. Risk tolerance is difficult to fully grasp until you've lived though uncertain times that force you to question how certain you are. If you're on the fence, select a more conservative option and as you become more comfortable with normal market fluctuations you can make adjustments.
You may find that you are not as risk averse or tolerant as you thought.
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This memorandum expresses the views of the authors as of the date indicated and such views are subject to change without notice. Samara has no duty or obligation to update the information contained herein. Further, Samara makes no representation, and it should not be assumed, that past investment performance is an indication of future results. Moreover, wherever there is the potential for profit there is also the possibility of loss.
This memorandum is being made available for educational purposes only and should not be used for any other purpose. The information contained herein does not constitute and should not be construed as an offering of advisory services or an offer to sell or solicitation to buy any securities or related financial instruments in any jurisdiction. Certain information contained herein concerning economic trends and performance is based on or derived from information provided by independent third-party sources. Samara Capital (“Samara”) believes that the sources from which such information has been obtained are reliable; however, it cannot guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based.
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