All of us are comfortable with different things in life. Some of us, for example, might have no problem bungee jumping or parachuting out of a plane, while for others, throwing a dab of hot sauce on our tacos is about as adventurous as we get.
The same holds true when it comes to investing. Sure, nobody wants to get burned by the stock market, but some of us are more fundamentally cautious than others when it comes to taking risks with our money. Understanding your risk tolerance can help you make better, more informed investment decisions, and with that in mind, we have a little quiz that can help. Our questionnaire will help you develop an asset-allocation strategy to grow your portfolio without losing too much sleep in the process.
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What's your tolerance for risk?
When it comes to investing, everyone has a different tolerance for risk. Knowing where you stand can help you devise a strategy for your money, and with that in mind, we have a quiz for you to work with:
Calculator is for estimation purposes only, and is not financial planning or advice. As with any tool, it is only as accurate as the assumptions it makes and the data it has, and should not be relied on as a substitute for a financial advisor or a tax professional.
Be sure to answer these questions as honestly as possible, because they'll help you better understand your risk tolerance. That said, it might also pay to jump outside your comfort zone if doing so helps you accumulate wealth more efficiently.
Your investments matter
You've probably heard that bonds are typically a safer investment than stocks, but that stocks tend to yield more favorable returns. And generally speaking, that's pretty much true.
What you may not realize, however, is just how much of a difference an aggressive investment strategy can make, as opposed to one that's far more conservative. Simply put, a stock-heavy portfolio is likely to deliver higher returns than a bond-focused portfolio over time. And choosing one strategy over the other could spell the difference between retiring with a sizable nest egg or coming up short.
Imagine, if you will, that you manage to save a relatively modest $300 a month throughout your 40-year career. Here's how much you stand to accumulate based on your investment strategy:
|
Investment Style |
Average Annual Return |
Total Accumulated Over 40 Years (Assumes $300 Monthly Investment) |
|---|---|---|
|
Aggressive – mostly stocks |
8% |
$932,000 |
|
Moderately aggressive – mostly stocks with some bonds |
6% |
$557,000 |
|
Moderately conservative – mostly bonds with some stocks |
4% |
$342,000 |
|
Conservative – mostly bonds and safer vehicles |
2% |
$217,000 |
TABLE AND CALCULATIONS BY AUTHOR.
Thanks to the power of compounding, with a stock-centric investment strategy offering an average annual 8% return, you can turn $144,000 of your own money ($300 a month x 480 months) into a whopping $932,000. That's a $788,000 gain! But the more conservative you are with your investments, the less impressive that number gets.
Now, this isn't to say you should load up on stocks and nothing else, or that you should ignore your feelings about risk completely if you're a naturally timid investor. In fact, diversifying your portfolio is a good way to protect yourself against long-term volatility. But if you're a naturally risk-averse investor, you might consider taking baby steps toward an asset allocation that increasingly incorporates stocks over time.
For example, say your current tolerance for risk translates into a strategy likely to deliver an average annual 4% return. You might slowly integrate more stocks into your portfolio so that you're eventually opening the door to slightly higher returns, which can make a sizable difference over time.
What's your investment horizon?
When evaluating your tolerance for risk, one thing to keep in mind is that your investment window -- the length of time you're looking to invest -- will play a big role in determining your ultimate strategy. Though stocks are a good way to grow your wealth, they're actually a poor choice if you're only looking to invest for the near-term. On the other hand, if your goal is to amass a nest egg for retirement, and you have 30 or 40 years to accomplish your goal, you have plenty of time to ride out the stock market's ups and downs, and ultimately come out ahead.
When you think about where to put your money, ask yourself how long you're able or willing to part with it. If the answer is seven years or less, then stocks may not be the answer.
One final thing to keep in mind is that your investment strategy can, and should, evolve over time as your needs and circumstances change. You might have a relatively high tolerance for risk now, but as you get older, you'll probably start thinking about shifting some of your assets into safer investments. Just as there's no such thing as a one-size-fits-all approach to investing, there's no rule stating that the strategy you start out with is the one you need to stick to for life. If you continue being honest about your risk tolerance and pushing that level within reason, you're likely to adopt, and adapt, a financial plan that ultimately serves your needs.
