Risk tolerance and the appetite for risk

Any savvy investor knows that one of the single most important concepts to learn as an investor is that of risk tolerance. Like a gambler, you need to know when to hold and fold. Timing is of the essence. Not timing things right could be the difference between making a great financial decision and making a terrible financial decision. Whenever you are making an investment decision, you need to know just how much of risk you can take on realistically. Risk tolerance by itself too is not the issue by itself either, because it can be either your emotional risk tolerance or financial risk tolerance that can come into question.

Financial risk tolerance is all about objective. It is all about the numbers. Your portfolio and your financial situation is all about the numbers and all of it can determine whether or not you can handle the risk that is being thrown your way. If we’re talking just numbers here, financial risk tolerance is all about how much money you can realistically afford to lose out on. Can you take a $200 hit? What it that becomes a $1,000 loss? How would it affect you? Having an objective view of the situation is critical. These are, after all, your finances that we’re talking about and the appetite for risk can be a very personal thing. For some, losing $1,000 might not be much and for some losing $200 might be a whole lot. Consider the impact of your decisions financially to understand what level of risk tolerance you stand at. Understanding your financial situation will help you better understand your financial risk tolerance.

It would be wonderful to take all of the emotion out of investing, but sometimes it’s just not possible. Sometimes, I’d go as far as saying it’s impossible. We are all influenced by our understanding of what is risk and our emotions only get magnified when it is our money that comes into question. We all worry about the future and what will become of us understanding the emotional nature of risk tolerance is as important as understanding the financial nature of risk tolerance. Getting stressed about the state of your finances could end up affecting multiple areas of your life. Your relationships, your health and the people in your life could all get affected if your financial state takes a turn for the worse.

If you haven’t got the emotional stability to deal with the ups and downs of investments, it might not make sense to hold on to that investment. Your mind will constantly be preoccupied with thoughts of what could happen with your money and whether you’ll lose it all or not. Conversely, you might be cock-a-hoop at growing your money and you might make a risky investment and lose it all, leading to a downward spiral fueled by anger and unstable emotionality. All in all, understand your risk tolerance, both emotional and financial before putting your money. You don’t want to take on more than you can handle.