Risk Tolerance

Many investors ask, "What is the least risky investment?" The answer to this question depends upon you and what your goals are. Depending upon what you want to achieve, the least risky investment in terms of short term deviation may be the most risky in terms of meeting your needs.

Your tolerance for risk is an important factor in how you allocate your investment portfolio among different types of investments. Risk tolerance refers to your ability to stay with an investment when the return is less than you expect or declines in value. You should only assume a level of risk that you are comfortable. Unfortunately, it is difficult to quantify an individual’s tolerance for risk. Even if you think you understand your tolerance for risk, you generally will not know for sure until you actually face a significant downturn in an investment.

Many investment websites offer free online questionnaires to help you assess your risk tolerance. Some of the websites will even estimate asset allocations based on responses to the questionnaires. While these suggestions may be a good starting point keep in mind that the results may be biased towards financial products or services sold by the sponsoring websites.

It is our experience that most investors overestimate their risk tolerance. When answering risk questionnaires most investors focus on what they want to do not on what they need, should or can do.

There are two factors that might impact your risk tolerance. One is the level of investment risk that is appropriate to you based upon your personal situation, such as, your time horizon, income level, asset level and family responsibilities. The other factor is your emotional tolerance for risk. Even though your personal situation indicates that you could assume a high level of risk it may not be wise if you are uncomfortable with that level of risk.

To be effective you have to answer the questions honestly and factor in your understanding of all investment options, your past experiences in the stock market, if any, the amount of research you are willing to undertake, your time horizon and family situation.

If you have minimal experience investing in stocks Waverley Research recommends you begin with an S&P index fund. Waverley Research also recommends that an individual stock comprise no more than 5% of your entire portfolio.