Not all investments are created equally. Each opportunity to invest your money comes with a varying mix of risk and potential reward. The keyword here is potential, because while increased risk enhances the scope for reward, larger returns are never guaranteed at higher risk levels. Are you looking to get into the investing game? Begin by looking inward.
The following descriptions can help you to determine your own risk tolerance.
Low – You work hard for your money and cannot bear the though of losing even a portion of it in an investment gone bust. You may be looking to retire soon or need a down payment for your next home. As such, you are reluctant to risk any portion of your savings. You want to earn a return but you don’t have much time to recover if your investment loses money. The dramatic swings in the stock market this year give you anxiety and you want no part in all that stress. Your risk tolerance is low.
Moderate – You take a realistic approach to the markets. You believe that in order to retire someday you’ll have to engage at least some portion of your earnings in stock and/or bond securities. You have some awareness of finance and you already have an emergency fund stashed-away in a savings account. You spend less than you earn and have the ability and self-discipline to make regular contributions into a retirement or other investment account. You have a trusted tax advisor and financial planner in your life and would only move a large sum of money after consulting with said professionals. Your risk tolerance is moderate.
High – You enjoy following the stock market and are comfortable with uncertainty. You are knowledgeable about finance and are not likely to be “sold” on a bogus investment just because someone or some company promises you “huge” or “guaranteed” returns. You have enough low- to moderate-risk money invested that you can afford to take on more exotic investments or purchase stand-alone stocks for speculation. You are not likely to sell off a large portion of your stock holdings just because the markets have a bad day. Your risk tolerance is high.
Do you have some money to invest? Whether this is a one-time investment of capital or a regular direction of earned income (i.e. payroll deduction), knowing your preferred level of risk will help guide your decision. Seasoned investors typically hold a portfolio that includes investments at all three levels.
Low – Low-risk investments are usually insured by a Federal agency such as the FDIC or NCUA. Investments at this level are not likely to yield sizable returns in the short-term but the capital can grow over time. Examples include savings accounts, certificates of deposit (CDs), Treasury Bills, and some municipal bonds. Returns are often dependent on the Federal Reserve Banks’ key rate, which is currently under 1%. Purchasing a home to live in is usually a low-risk investment that is likely to appreciate at a rate of 3% per year.
Moderate – Fixed-rate, non-guaranteed investments usually fall into this category. Some stock and bond investments with variable rates carry moderate risk. Returns are modest but stable and the capital also grows as with a low-risk investment. Examples include exchange-traded funds (ETFs), which hold a calculated mix of stocks or bonds in aggregate but trade as one security. Some stand-alone bonds also fall into the moderate-risk category. Purchasing an investment property to manage and lease to another party is an investment that carries moderate risk in most geographic areas.
High – With a high-risk investment, large returns and gains are possible, but so are large losses. These investments are not insured or guaranteed. Examples include stand-alone stocks, venture capital (such as S-corp. shares), and speculative real estate. Cryptocurrency and the futures market also present high-risk investment opportunities.
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