What Kind of Investor Are You?

Most Americans seem to understand that to pursue financial gains through investing, they typically must assume some level of risk. For example, one survey of investors with household incomes above $150,000 found that 98% were willing to assume at least some risk in pursuit of investment gains (see chart below).

When you assume investment risk, it means you should be willing to lose money in pursuit of investment gains. Although losing money is exactly the opposite outcome you hope to achieve through investing, risk is an inherent aspect of investing. Broadly speaking, the more risk you are willing to assume, the greater your potential for investment returns.

Understanding your risk tolerance is an important part of determining what kind of investor you are. At one end of the risk spectrum is the conservative investor, who is usually interested in preserving principal and earning a steady income. At the other end is the aggressive investor, who is typically more concerned with growing principal, even if it means sustaining some investment losses along the way. Not sure where you fit? These factors may help you decide.

Comfort Level

Everyone has a different comfort level when it comes to the potential for losing money on an investment. Although feelings are important and should be taken into consideration, making major decisions based on emotion could cause you to miss opportunities or take on too much risk. Remember that even the most conservative investments can lose value over time if they don’t keep pace with inflation.

Time Horizon

Your proximity to your financial goals can have a significant influence on your risk tolerance. In general, the more time you have to reach your goal, the more risk you may be able to assume. An individual who is 15 to 20 years from a major goal, such as retirement or sending a child to college, is typically in a better position to recover from investment losses than someone who is five years from a major goal. As you approach the date when you will need the money in your portfolio, it may be a good idea to begin shifting assets to more conservative vehicles to help avoid losses from which you may not have time to recover.

Net Worth

The size of your portfolio could also affect your risk tolerance. Consider two hypothetical investors: One has a $5 million portfolio and the other has $100,000 in a retirement account. Each makes a $50,000 investment in the same security. The millionaire is assuming far less risk because $50,000 represents only 1% of his portfolio. The other investor is facing a much larger risk by exposing half of his portfolio to the fate of a single security.

All investments are subject to market fluctuations, risk, and loss of principal. When sold, investments may be worth more or less than their original cost.

Determining how much risk may be appropriate for your portfolio typically requires you to consider more than just your feelings. Examining your overall situation may help you determine how much risk you want to assume to meet your long-term financial goals.

The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. © 2011 Emerald Connect, Inc.