Understanding your risk level is critical to understanding the investment strategy you should follow. It is also crucial that you understand that there is always risk involved when investing. 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 level and give you ratings if you want it. It is not essential to complete a questionnaire but some find this useful. What is essential is that you challenge yourself and give this the thought it deserves.
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 financial situation?
- Do you have disposable income?
- What are your future financial commitments, mortage, children etc.
- Can you afford the risk of a loss?
- Consider your age – do you have time to recover from a financial loss?
RISK TOLERANCE (Mental Aspects):
You might have the money to take a risk, but are you MENTALLY PREPARED TO ACCEPT IT?
Taking a loss can be a blow to your pride and cause anxiety. Everyone loves the excitement and joy of seeing good results but how good are you at losing? This is worth considering because whilst taking a loss can be stressful, it can also lead people to make bad decisions when trying to recover that loss.
RISK APPETITE (Goal Aspects):
As you will have already considered your GOALS (what you want to achieve and by when) you should also know HOW MUCH MONEY YOU NEED to achieve your goals. This is where your risk appetite comes in. If your goal requires a small steady return over the next 20 years, low risk investments should be sufficient. If your goals require the need to increase funds dramatically or quickly, then you will need to consider higher risk investments.
Write down your thoughts for each section and reflect on this to understand what your personal risk level is.