When it comes to investing, determining your risk level is the first step in planning your strategy. Stop and think. Do your endorphins start rushing when you’re teetering on the edge of danger or do you have heart palpitations? Are you comfortable taking big chances for the possibility of reaping large rewards, or are you more content to play it safe for more modest, but more reliable rewards? Your answers to these questions will give you a sense of your risk tolerance levels, but to determine your full risk profile, you’ll need to dig a little deeper.
Assessing your risk range is a calculated exercise that considers your time frame for meeting specific financial goals, investing experience and comfort level with worst-case scenarios. Even if you’re young and have a long-term horizon, you may not necessarily be comfortable investing aggressively.
There are other factors that can impact your tolerance of investment risk as well, such as your personal experiences and history, personality, current circumstances and future prospects. For example, maybe you are risk-averse because you got burned by a previous investment (or relationship) or saw your parents lose much of their nest egg in the last downturn. Or maybe you are an A-type entrepreneur and your whole life is about risk-taking.
If you want additional help figuring out your risk profile, there are plenty of free calculators available online with recommendations for the appropriate corresponding investment mix (or “asset allocation”). Charles Schwab offers a questionnaire in PDF format that you can save on your computer and print out. It also includes their asset allocation models, which interestingly illustrate that the difference in average annual returns between their most conservative and most aggressive portfolios is just 2 percent, but the worst-year return difference is over 31 percent! This goes to show that you can still get competitive returns with a “conservative” portfolio and that having an “aggressive” portfolio is sometimes not worth the risk (or anxiety).
Keep reading for more on how to invest for your risk profile.