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Determine Your Risk Tolerance

This lesson is a part of an audio course Become a Self-Directed Investor by Damanick Dantes

Whenever there's money involved, you can expect some level of risk. Naturally, we all want some high level of return with the lowest amount of risk but that doesn't come easy.

Before we even start to discuss risk, let's get one thing out the way: Being an educated investor is the ultimate safeguard against losing it all. Unfortunately, there are many bad actors in the financial industry that prey on uneducated investors. So, start by avoiding things that seem complex, and schemes or products that you don't fully understand.

So, what is the risk? It's simply the possibility of something bad happening. For investments, a bad event is when market prices go in the opposite direction from your starting point. In other words, when you see a negative number indicating a loss. Ups and downs in the market are what we call volatility or the variability of returns. Nothing goes up in a straight line.

Losses can occur at any moment throughout the life of your investment, but your tolerance for risk will determine if you're willing to hold on or cash out.

There are two types of investors: Conservative and Aggressive. A conservative investor has a low-risk tolerance and prefers to maintain their original investment with the potential of smaller profits over a short period of time. On the other hand, an aggressive investor is able to handle market swings by having a long-term horizon. They're in seek of investments that provide higher returns such as stocks.

To be clear, even if you're relatively young, it doesn't mean that you should take on excessive risk. Remember, there is a greater possibility of loss with more risky assets you hold. For example, a young investor would typically concentrate their portfolio on stocks given their long-term horizon. But not all stocks are equal. You have risky stocks in industries such as pharma and tech as opposed to your more comfortable buy and hold staple names such as Coca Cola and Kellog.

As a self-directed investor, meaning someone who is going to bypass traditional retirement plans and employer-sponsored investments, you shouldn't be silly and place all of your money in high flying tech stocks like Apple. You'd want to balance your portfolio and reduce your risky investments over time. As you age, your focus should be on protecting the gains that have accrued from riskier growth assets during your younger days.

So, you can see how risk tolerance is all dependent on your objective and the investments you choose.

Your task is to determine what level of risk you can tolerate. Are you more aggressive or conservative? Do you have more time to recoup potential losses or less? Once you have that set, we can start building your portfolio.

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Written by

Damanick Dantes

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