Your Personal Tolerance for Risk
Whether deserved or undeserved, emotions often play a huge role in the type of investing you do, or whether you invest at all. For example, do you dismiss any sort of stock investment as too risky to even consider? Does your tolerance for risk begin and end at savings accounts and certificates of deposit? Or are you the first one to drop all your investment dollars on the latest new stock offering that is supposed to be the next big darling on Wall Street? In both scenarios, your emotions are dictating how you invest.
In investing, like life, there are no guarantees. However, if you take an informed approach to investing, you can take into account actual risks and opportunities. If you refuse to consider any investment other than savings accounts or certificates of deposit because you fear you could "lose everything," you're allowing fear to prevent you from seeing returns on your investments that you could be well equipped to make. Or if you continuously sink all your funds into the investments that promise the highest return with the lowest expenditure, chances are that you're not only losing your shirt more times than you care to recall, but that you are also missing out on investments that can help you achieve your goals.
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Tip
Your emotional risk tolerance is different from the risk and return analysis that is a fundamental part of any successful investment plan. As a matter of fact, this sort of analysis can help you overcome your emotional mindset about risk because it is based on the actual risks and returns of specific investment vehicles, as well as the age and stage of your life when you are making the investment.
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By now you're wondering what you can do about your emotional baggage other than go into therapy. While we would never dissuade anyone from pursuing other avenues, once you recognize that you have an issue with risk, there are two basic steps you can take to get your investments on course:
- Become knowledgeable about fundamental investment principles. You're already on your way by getting this far. Knowledge is the most powerful tool you have when it comes to investing, and understanding the basic principles behind investing can prevent you from making costly mistakes based on false perceptions.
- Set specific goals. Once you set your goals, you can realistically assess the level of risk appropriate for what you are trying to accomplish in the time you want to accomplish it.
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