Know your investment profile & avert the stress away

Investing can feel scary, so much so that some people completely avoid it. If that sounds like you, because you are afraid of a total loss, it’s time to learn how investing works and why risk is important. In addition, it’s vital to understand that just because you invest doesn’t mean you’ll lose everything.

Investing is the best way to meet your financial goals and increase your net worth. But, contrary to what most believe, it’s not necessary to take high risks; there are ways to invest while minding your risk tolerance.

The key, however, is understanding what you can risk to make financial gains and enjoying the short and long-term benefits of investing.

Understanding your Risk Profile

Your risk profile helps you determine what investments to choose. But, of course, no two investors have the same risk profile, and one isn’t better than the other.

The key is understanding what you can handle.

A risk profile has two key components – risk aversion and risk capacity.

Risk aversion or risk tolerance is your comfort level with losing money. 

It’s not a monetary measure; instead, it measures your psychological capability of investing. In short, it measures how you’d handle a financial loss.

Some people can handle a loss and move on, not letting it ruin their day or future. Others feel crippled by any loss and might go as far as pulling everything out of the market for fear of losing more.

Your risk tolerance can be shaped by your financial history, emotional makeup, and the people you are with daily. 

For example, if you’re around people who invest aggressively, that energy might rub off on you and make you want to do the same. But if you are always with people who keep it conservative and are afraid of loss, it could shape your thoughts too.

Risk capacity is a monetary measure of how much you can risk.

For example, if you’re investing money you need shortly, or that would devastate you financially if you lost it, your capacity is low. However, if you have money you can afford to lose that wouldn’t affect any immediate goals or financial needs, your risk capacity is higher.

Choosing your Investment Terms

When determining your risk profile, it’s important to categorize your goals into short, mid, and long-term categories. 

• Short-term goals are those you want to achieve within the next year. Your timeline for these goals is short, so you’ll typically invest less aggressively to meet your goals and avoid a loss. 
• Mid-term goals are those you want to achieve in the next one to five years. You may have a little more time to invest aggressively until you’re closer to the goal’s due date, then you’d scale back to be more conservative.
• Long-term goals are those that you want to achieve in five years or longer. For example, retirement is a common long-term goal, as is saving for college or other large expenses.

Diversifying your Portfolio

Diversifying your portfolio is key to investing according to your risk profile. Even investors with a high-risk tolerance should have a diversified portfolio.

When you diversify, you invest in risky and conservative investments. 

You also try to invest in different industries and asset types to ensure you aren’t putting all your eggs in one basket. For example, if you put all your money in one stock and it crashes, you’d lose everything.

However, if you invest in multiple stocks in different industries, as well as bonds, crypto, and commodities, you lower your risk of losing everything.

Some common investments to consider to diversify your portfolio include:

• Preferred stock
• Common stock
• Dividend stocks
• Bonds
• Commodities
• Venture capital
• Real estate
• Crypto
• Gold/silver
• Crowdfunding

Learn to Reallocate your Portfolio

A key factor in investing and reaching your goals is understanding how to reallocate your portfolio. For example, your portfolio might get off balance based on your goals due to market performance as time passes.

For example, if you had a conservative portfolio, but your stocks outperformed your more conservative investments, your portfolio might be more stock-heavy than you’d like. Reallocating your portfolio allows you to sell some of the stock and invest in more conservative investments to rebalance your risk.

Why Risk is Important

You might wonder why you should take any risk. Can’t you invest your money in a savings account and keep your money safe?

While money in a savings account is safe, it’s also not growing. Even an online high-yield savings account’s interest rate can’t help you achieve your long-term financial goals. You’ll earn a little money on your savings, but not enough to see a dramatic difference in your finances.

The more risk you take, the higher the reward. 

This doesn’t mean you should risk everything and only invest in risky investments. Instead, you should balance your portfolio, so you invest in a combination of risky and conservative investments.

The risky investments will have a higher reward when they work well, and the conservative investments will back you up in a time of loss. 

Common conservative investments include bonds, some common stock, and CDs (certificates of deposit). But, of course, every investor will have different options for investing in risky and conservative investments.

Final Thoughts

Managing your risk tolerance combines knowing what you can afford to lose and understanding your mental tolerance.

Some people like the thrill of investing and the risk/reward accompanying it. 

Others cannot handle much risk and lose sleep at night, wondering if they’ll have enough money to pay their bills.

Take your time assessing your risk tolerance, and reassess it periodically as it might change. 

Then, change your investing style with what you can afford to lose and how your goals change over time to determine your risk tolerance and the best investment strategy to reach your goals.