The Importance of Understanding Your Investment Risk Tolerance

It is quite obvious that every person has a unique amount of tolerance to risk both as it relates to investments and things outside of investments. While it is easy to simply blow it off as not very important, the truth is a very thorough knowledge of your investment risk tolerance is absolutely essential to having the right assets in your portfolio.

Risk tolerance as it relates to investments is defined by Investopedia as the degree of uncertainty that an investor can handle in regard to a negative change in the value of his or her portfolio. Basically, risk tolerance is understanding how well you would be able to take it if your portfolio loses a large amount of its value. There are some people who have almost no risk tolerance at all, which means that the stock market is certainly not a wise investment for them. Other people have a much larger tolerance for risk because they are simply seeking aggressive growth in the long run, meaning investments in riskier assets such as individual stocks and possible even options may be right for them.

The good news is there are a huge amount of asset types available to investors, so there is no lack of options when it comes to how tolerant you are of risk and what you could buy. The spectrum goes all the way from the safest of the safe, such as things like treasury bonds and certificates of deposit to the riskiest of all, which is widely considered to be individual stocks and especially stock options. Obviously in the safe assets you will earn less over time, but you will also sleep much easier at night.

How can you know what your risk tolerance is? Factor in important things such as how much of a loss you can possibly afford in your personal portfolio, your age, your financial goals, and your emotions. There are some risk tolerance quizzes online which can be very helpful, or you can sit down and talk to a financial advisor or professional who has experience with understanding tolerance of risk.

The most important thing is that you figure out your tolerance for risk BEFORE you start investing your hard earned money. You can't afford to ignore risk tolerance when putting together your investment portfolio. Those who don't consider risk tolerance and then go head first into assets such as individual stocks are typically the investors that are hurt the worst. Make yourself an informed investor and make wise investment choices for your portfolio!