It is extremely important to have investments. Without some money set aside for retirement, you will never be able to enjoy your golden years. Social Security will likely be depleted within the next 30 or 40 years, so you should not be depending upon the U.S. Government to take care of you when you retire. Besides, Social Security does not even pay enough to help senior citizens live comfortably. So, you need to invest your money wisely, perhaps aggressively, in order to grow your portfolio to a level that will adequately support you after you retire, and you need to start while you are still young.
You need to ask yourself the following question when deciding in what you are going to invest: What is your investment risk tolerance? Answering this question will enable you to develop your entire investment strategy. Are you going to put all of your money into variable securities, like stocks? Are you going to balance your portfolio with a mix of stocks and fixed-income securities (like certificates of deposit or other money market instruments, etc.)? Should you buy bonds? Should you invest in an annuity?
Answering these questions can be difficult and time-consuming, but necessary nonetheless. When evaluating your risk tolerance, you should first consider what type of person you are. If you like to take risks, then invest accordingly. If you hate to take chances, then play it safe. Also, you need to assess what your long-term goals are. Do you want to make a lot of money, or just enough to retire on? Do you have kids that you will one day want to send to college or provide other financial support to?
We will now set forth an appropriate investment strategy for each different risk tolerance, beginning with high-risk tolerance. If you are not afraid of losing money and do not have any kids or other responsibilities weighing you down, then you might consider putting together a very aggressive portfolio. In this case, you should have a portfolio that consists of mostly equities (stocks). The stocks you select should be companies that have the potential to grow tremendously. The higher the risk, the higher the potential reward. Though you should still keep some of your money invested in blue-chip companies with stable finances, you should put a great deal of your money in new companies, hedge funds, and perhaps junk bonds. You should consult with a financial advisor when looking for the right hedge funds or junk bonds in which to invest.
What if you have a medium risk tolerance? Well, for those of you that fall in the middle, the answer is simple. You should have a balanced portfolio. You need to have a mix of stocks, bonds, and fixed-income securities. You may want to set aside a very small amount of money for speculative investments such as the aforementioned hedge funds, penny stocks, or perhaps derivatives, but most of your money should be allocated towards a mix of stable small-cap, mid-cap, and large-cap stocks, government and corporate bonds, and fixed-income securities.
Finally, for those of you who are extremely risk averse, you need to compose a portfolio that consists of mostly high-yield government bonds and certain money market instruments that pay a decent interest rate. You should also invest in corporate bonds issued by companies with a high credit rating, and stocks of companies that consistently pay dividends (dividend income will help to offset any losses in the share price of the stock).
I hope this information will assist you in making your investment decisions. Formulate a plan to set aside a certain percentage of your income for investing on an annual basis and start while you are still young. The earlier you begin, the more money you can potentially make down the road. Using your risk tolerance, select a portfolio that meets your needs, and you should do fine.
Both of these factors can be combined to make up your investment policy and investment philosophy.
It's important to understand that your risk profile is really comprised of two aspects: your risk attitude and your risk capacity. Risk attitude is the true measure of your personal comfort with risk. Are you willing to risk a less favourable outcome whilst attempting to achieve a more favourable one? (risk vs return).
Risk capacity is your ability to sustain a less favourable outcome without jeopardising your original goals and objectives. Risk capacity is affected by factors such as time horizon (allowing you time to recover from an adverse return) and total wealth (allowing you to go through a decline in account value and still maintain your desired spending).
The two areas are as important as each other and it is vital that you take both into account when making important investment decisions. For example, if your risk attitude means that you could sustain a 25% market decline without any impact on your goals, the appropriate portfolio may contain 60-80% equities.
However, if your risk attitude measure indicates that any decline in excess of 10% would cause you cold sweats and sleepless nights, then the 60-80% equity portfolio is clearly not the right approach. Instead, you should be invested into a portfolio with a lower percentage of equities.
So, how can you address your full risk profile?
There are two keys:
First, you must obtain a true measure of your risk attitude.
This can be obtained by using a comprehensive risk profiling system. You won't be able to achieve this by second guessing it yourself, as it's highly unlikely you'll know enough for the assessment to be successful. You should speak to your Financial Adviser/Planner and ask them what they're using. One of the most comprehensive tools is provided by FinaMetrica. Their assessment contains 25 questions and your score (1-100) will be compared against the whole pool of those who have completed the questionnaire.
You should then make sure you interpret the score correctly and are able to act upon the information effectively.
Secondly, you should work through a process of financial planning to determine your true goals and objectives. This step is CRUCIAL as without it, how will you know what your tolerance is for risk capacity (i.e. how will you know how much loss you can absorb without it affecting the likelihood of you achieving your goals).
Once you know how much downside you can tolerate, you can then determine what the appropriate investment policy should be, using risk attitude as a constraint. This should lead you towards deciding what percentage of equities you want in your portfolio.
The alternative approach is that you remain invested in a higher percentage of equities, but prepare yourself that you may need to adjust your goals (retire later, spend less, spend more, etc) if the portfolio value falls too much. Of course, you may reach your goals sooner if the higher risk portfolio grows at a faster rate than the lower risk portfolio.
The Financial Tips Bottom Line
When you break it all down, it's more than likely that you're trying to achieve your goals and objectives in some form. And most people would rather try and reach their goals with the minimum amount of risk (yes, note I said some people - there'll always be the risk takers amongst us).
ACTION POINT
The subject of investment risk should not be underestimated. If all you've done up to now is assess your risk on a scale of 1-10 (and believe me, this is VERY common), maybe it's time to take a more comprehensive approach. After all, it's only going to improve your understanding of your own risk tolerance and how much risk you can afford to take.
Both Jim Pretin & Ray Prince are contributors for EditorialToday. The above articles have been edited for relevancy and timeliness. All write-ups, reviews, tips and guides published by EditorialToday.com and its partners or affiliates are for informational purposes only. They should not be used for any legal or any other type of advice. We do not endorse any author, contributor, writer or article posted by our team.
Jim Pretin has sinced written about articles on various topics from Insurance, Medicine and Homeopathic Remedies. Jim Pretin is the owner of , a service that helps programmers make email forms.. Jim Pretin's top article generates over 33100 views. to your Favourites.
Ray Prince has sinced written about articles on various topics from Finances, Babies and Property Guide. Ray Prince is an Independent Financial Planner with Rutherford Wilkinson plc, and helps UK Resident Doctors and Dentists get the best deals on mortgages, protection and investments, as well as helping them achieve their financial objectives. Click here fo. Ray Prince's top article generates over 33100 views. to your Favourites.