Your risk tolerance determines how much of your money you’re willing to stake in risky investments. In a bid to grow your income, it is always advisable to invest your money in the different available options. These options are categorized into high-risk and low-risk investments. High-risk investments can grow your income exponentially in a short period but can wreck your finances if they go south. Examples are forex and stock trading. Meanwhile low risk investments are much safer but won’t grow your money as quickly as you want. Examples are bonds, money market, etc
There are three categories of risk tolerance, The Aggressive Investor who is willing to risk it all in a bid to earn high returns, The Moderate Investor who dabbles in both high risk and low risk investments, and The Conservative Investor whose priority is preserving the capital and is satisfied with lower returns.
So, “what is my risk tolerance?” you may ask. The answer will vary based on a few factors to be considered. Here are the major factors:
1. Age : Your age plays a huge role in determining your risk tolerance. When you’re younger, you have enough time to recover from high risk investments, so feel free to explore all the investment types you want to. On the other hand, when you’re close to retirement, you have no business dabbling into risky investments, unless of course, you have more than enough money for your retirement.
2. Experience : Your knowledge about a type of investment and your experience will determine how much you should invest. It is not advisable to invest a large chunk of your income in an investment that you haven’t mastered to certain level. For instance, trading forex and stocks require a lot of experience, do not be tempted by the gains someone else is making and venture into it prematurely.
3. Net worth : Your risk appetite is greatly influenced by your net worth. It’s quite simple, the more money you have, the more you will be willing to “play” with. It would be quite foolish to dabble into some high risk investments if you don’t have enough money to fall back on, should it go sour.
4. Investment or Trade Being Considered : The details of a trade will reveal the level of risk involved and this will determine how much much you should invest and if you should consider it at all. For instance, if a certain type of investment has been doing well for a considerable amount of time, you may be willing to increase your risk tolerance.
Once you have thought this through, you will be able to apply this knowledge to a balanced and diversified program of investing and trading.