Every Investor Should Know Their Risk Tolerance
Even if you've only recently started saving and investing, you probably know that the stock market fluctuates -- often dramatically -- from day to day. These fluctuations impact the value of your investments. This can cause some investors to become very anxious, and to question their decision-making and commitment to an investment strategy.
Risk tolerance is a measure of how emotionally comfortable you are with taking financial risk. For example, how much you're willing to see your portfolio's value decline for a chance to see it earn larger returns. Risk tolerance is psychological.
Risk profiling is a process for finding your optimal level of investment risk by balancing the amount of investment risk required, your risk capacity and your individual risk tolerance.
By knowing how comfortable you are with the variability of investment returns, you can make sure you don't panic when the markets take one of their periodic tumbles. Bear markets -- when stock prices fall 20% or more from their most recent high -- generally occur every 7 to 10 years. So, depending on your age, you're likely to experience five, six or even seven of these gut-wrenching episodes in your investing life.
Measuring your risk tolerance is more complex and nuanced than a four or five question checklist from your broker. Fortunately, there are several robust tools available, a number of which are free.
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