Understanding your risk level is critical to understanding what strategy you should use. It is also crucial that you understand that there is always risk involved. You need to understand risk and manage it.
RISK AND REWARD come hand in hand. If you are only willing to risk a small loss, then your potential gain is likely to be small. If you are willing to take a higher risk, then your gain is likely to be higher too.
There are surveys and questionnaires available on the internet that will assess your risk and give you ratings if you want it. You don’t have to have a rating though. You just need to give it some thought, challenge yourself and use your common sense when it comes to investing.
The easiest way to break your risk level down is to split it into 3 sections:
RISK CAPACITY (Financial Aspects):
You need to understand how much risk you CAN AFFORD TO TAKE. What is your current financial situation, do you have money you can afford to lose? Do you need to keep specific reserves for financial commitments such as mortgage, family, retirement etc. Also what is your age? If you are young you have time to recover from a financial loss, if you are retiring or already retired, you do not want to be risking your retirement fund.
RISK TOLERANCE (Mental Aspects):
You might have the money to take a risk, but can you MENTALLY ACCEPT IT. It can be a blow to your pride if you take a loss, or the stress of seeing a loss can be too much for some people. Everyone loves the excitement and joy of seeing good results, but how good are you a losing? This is worth thinking about not only because a loss can be stressful, but it can also lead people to make bad decisions trying to recover that loss.
RISK APPETITE (Goal Aspects):
Hopefully you have already thought about your goals, what you want to achieve and by when. You should also know HOW MUCH YOU WANT OR NEED to achieve your goals. This is where your risk appetite comes in. The more you need the higher your risk appetite. If you only need a small steady return over the next 20 years you will probably be OK with low risk investments. If you need to increase your funds dramatically in the next 10 years or sooner, then you will need to look at higher risk higher return investments.
Write down your thoughts for each section and balance them all together.
You don’t need to give your self a score but you do need to understand and admit to yourself what your risk level is.