Determining your tolerance for risk is at the core of managing your portfolio. It is what you use to assess the volatility of the market, to reallocate your assets, to determine your personal financial goals. Risk is at the heart of investing. With that said, differentiating between risk and uncertainty is important. The simplest explanation is that you can measure risk, whereas you can’t measure uncertainty.
Risk is in not necessarily a bad thing. Let’s remember that since the height of the crisis, some investments have done extremely well, despite the general view that the investment environment is still unfavorable. Whereas one person becomes weary, another can become optimistic when faced with the same market risk. Risk is what keeps us up at night but also allows our investments to grow.
Because we use risk to evaluate the market, investing becomes an ongoing process that at times can be exhaustive and at which point, appears as uncertainty. When deciding on the level of risk you are comfortable with, look at such factors as age, location, stage in life, goals, family size, income, etc. All of these variables can increase or decrease our feelings of how risky a portfolio we can manage.
In general, there are three main types of risk-taking personalities and expertise levels: Conservative, Moderate, and Aggressive.
Conservative: Even in this category there are various types of conservative personalities. There are those who can’t afford to lose anything and want their savings to just adjust for inflation. Others who have been burned playing the stock market and have become cautious. Some are about to retire and can’t afford to lose too much. The tolerance of how much one can stand to lose also differs. Some can withstand high single-digit losses, whereas others can’t, and have most of their savings in cash and bonds.
Moderate: This is generally the largest category of investors. They take a “practical” approach to investing and are looking to neither outperform nor under-perform the market. Their financial portfolio extends the range of asset classes and risk. Like it says in the name, they are looking for moderate annual income yields with some capital gains.
Aggressive: This group is fully prepared to take on substantial losses for the chance of reaping huge rewards. The stereotypical view of this group is that they are young, high-income earners with a constant income stream to contribute to their savings, and the time to recoup their losses. On the other hand, they might just be a group of individuals in a hurry to get wealthy in the shortest time-span possible. While this group typically gains little-to-no annual income yields, they earn a high amount from capital gains.