Every individual, whether you are middle-aged investor, retired or a new college graduate, has something called a financial risk profile. Generally speaking, this is the amount of financial risk you can tolerate based on a host of criteria–including such things as your age, income, employment status, location, and so forth. Your risk profile may also takes into account preferences you have personally for a level of risk. Are you someone willing to take some chances or do you always go for the safe bet?
When you get ready to analyze your personal risk tolerance you have to take into account your current financial situation as well as plans you have for your immediate future and those in the long term. Are you saving up for a down payment on a house? Is your child about ready to graduate from high school and you are saving for college? What exactly are the big ticket items on your horizon? And furthermore, where do you see yourself in 20 years? How about in 30?
After you’ve factored in things like your age and income and then identified your spending plans–both short and long term–it is time to work through some hypothetical situations. For instance, imagine one of your investments has taken a turn for the worse and is down 20% or so. Do you jump ship right away to reduce any further losses, hold on and wait for the tide to turn, or do you take advantage of the lower price and invest some more? The way you see yourself handling this situation should tell you something about your financial risk tolerance.
Another hypothetical scenario you could place yourself in is something like a game show where you’ve reached a certain prize level, say $25,000, and now you have a decision to make. Do you walk away with your prize, just happy to have won? Do you choose to continue with a 50% to double up your money or possible lose it all? How about a 5% chance to win a million dollars once you’ve already go $50,000 in the bank? Try to put yourself in the contestant’s position and see what you might do. The way you’d play the game can help you figure out your own risk profile.
If you’re able to work through the basic components that make up your financial risk profile and come to a better understanding of what you are able to tolerate–both due to your present situation as well as your appetite for risk–you will be better equipped to work through your savings and investments.