How much risk can you take in your investments? How do you determine your investment risk tolerance? What can you do to afford high risk investments?
These are just some of the questions that you might be asking yourself if you’re thinking about investing. I’ve likewise wanted to know the answers to these and that’s why I did some online research about it. Moreover, I also asked my friend who works as an investment banker to share some of his views on this topic.
And so I learned that each of us has different propensities for risk. Whether money is involved or not, we make decisions everyday based on the level of risk that is acceptable to us.
For example, riding an elevator exposes us to the risk of getting stuck inside. This fear can paralyze some people which will make them avoid taking elevators; but for most of us, getting stuck inside an elevator is a risk we can afford to take.
Why? Perhaps because we know that the chances of that happening is very low, and if it does happen, we believe that it’s not life threatening and rescue will come in a matter of minutes.
This scenario brings us to our first lesson about risk tolerance – and that is to have full understanding of your investment.
Whether you’re thinking of investing in mutual funds, in the stock market, in a business venture or whatever else, always be sure that you know how the investment instrument works.
A lot of people say that investing in the stock market is very risky, but why do some investors make lots of money from it? I dare say it’s not because of luck but because of extensive planning and research of how the market will move that gives them success.
Another major factor that affects your risk tolerance is your financial status. How so?
Let’s pretend that you have P50,000. Where among these two would you invest in?
Investment A: 50% chance of earning 100% (you’ll end up with P100,000) but there’s a 50% chance of losing everything
Investment B: 80% chance of earning 10% (you’ll end up with P55,000) but there’s a 20% chance of losing everything
Did you choose the second one because it is less risky? But what if I told you that you have P1,000,000 in the bank? Would you have chosen Investment A? I would.
It’s well known that most high-risk investments give the highest yields. So how can we afford to invest in them? The answer is by being financially stable.
Imagine the worst case scenario and determine how it will affect you. If you have an emergency fund, several assets and multiple income streams, then you can surely afford to buy some high risk investments.
So what else affects your investment risk tolerance?
The last one is your future financial requirements. Everyone needs to have an investment goal – that is to know exactly for what purpose you are investing for. Is it to buy a house? Start a business? Save for retirement?
Knowing HOW and WHEN you’re planning to use the money affects the level of risk you can take with your investments.
If you plan to spend the money in the near future for something necessary, then you might have to be conservative with your investments. But if you can afford a long holding period for your investment or you’re planning to use it for less essential things, then a high risk investment is something you can definitely consider.
This last one made me realize that it’s really better to start investing at an early age because when you’re young and single, you tend to have less financial obligations. More importantly, you can afford to hold on to your investments until poor market conditions become better.
In summary, if you want to know how you can increase your investment risk tolerance and profit from high-risk investments, then you need to consider three things:
- Have full understanding of what you are investing in.
- Make sure that you are financially stable.
- Know your investing objectives and financial goals.
Can you add anything more? Please share them below as a comment. Also, you might want to read my previous article, A Beginner’s Guide To Investing In Anything and Everything to help you get started in investing.
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Photo courtesy of Snoober
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