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Risk Tolerance, Self Assessment Exercise

This article is about checking, in a general sense at least, how much risk you can tolerate with regard to making investments. You'll find ten items to make judgments about and score yourself on. While it might be nice to have some sort of summary pattern of total scores to compare yours with that then tells you what sort of investments are suitable for you, you'll not find that here. Sorry about that. Rather, this exercise will lead you in thinking that question through for yourself.

Each item will have a brief comment below it having to do with why the item is important to think about with respect to putting in place an investment plan that will both grow your nest egg and let you sleep at night. Believe me, there's a lot to be said for worry free sleep!

Before you begin, I need to point out something. When you add up all your response scores the lowest possible total is 10, and the highest possible is 50. The meaning of a higher or lower score is different than when you were taking exams in high school and college. Then high was good and low was not good. Not true for this exercise. Higher or lower scores are neither good nor bad in some general sense. The effort is just to find out for yourself what's right for you.

Ok, here we go.

1. Your current age is:

The younger you are, the more time you have to make up for any financial reversal before you need to rely on your investments for income. That doesn't mean, however, that you ought to take a gambler's view of investing and do a series of highly risky ventures. The older you are the less time you have to make up for reversals, the less time you have before you'll need to use the money, and the more you ought to look to the safety of interest bearing instruments for the bulk of your invested money.

2. Your current annual income is:

This one is obvious. The less your ordinary earnings are, the lower your risk tolerance is---or should be---because you'll need most of your income for daily needs. That does not mean that you shouldn't save and invest, only that a reversal will make things harder for you. The higher your income the more money you ought to be able to free for investment, and the less a reversal will impact your daily life.

3. Your current financial responsibilities include:

This one is pretty clear too. The higher the number of loved ones who are dependent on your income and financial management, the less risk will be tolerable. Doesn't mean you shouldn't invest. It just means you'll probably want to be more conservative when you do.

4. Your current residence is:

This item looks sort of like the scores are reversed from what they ought to be, but the issue is priorities. Quite often the best investment a person can make is in a house and property. If you are living with parents or in an apartment, you might want to consider saving for and buying a home a very high priority. If you already own the home you plan to live in for a long time into the future free and clear, you'll have extra money to invest (your previous house payment) and reasonably small financial reversals won't hurt your net worth too much. You will still want to limit your risk, however, and avoid "opportunities" that seem too good to be true, but you can be a little less conservative.

5. Which of the following best describes your spending patterns:

This one is about priorities too. Credit card debt is a drag on finances if a person doesn't pay them off every month. Impulse spending and high levels of credit card debt sort of go hand in hand, by the way. So if you find your cards are mostly maxed out and you're paying the minimum on the balance a lot of the time, your priority should be to get a better handle on your spending patterns and investments you make should be conservative. If you have your spending well in hand, your risk tolerance level can be higher.

6. Which of the following best describes your savings patterns:

Again, we're looking at priorities. Spending patterns and savings patterns often have an inverse relationship to each other. If your spending isn't under good control you probably find it hard to build savings. Further, a high priority ought to be building a savings reserve for any financial emergency such as the loss of your job, injury that prevents you from working, or family health problems that prevent you from working and drain your bank accounts.

7. Years before you need to draw on your investments:

This item relates to age as does item number one. The longer you have before you'll need to use the money the higher your risk tolerance. The less time you have the more conservative you should be in making investment choices.

8. Which of the following best describes your view of investing in the stock markets:

Common stocks of American companies probably offer the best investment vehicle for growing your nest egg significantly beyond the rate of inflation. It isn't gambling if you choose stocks of solid companies and plan for long term investment rather than short term trading. You are buying part ownership in successful businesses. However, if you really do view stock investment as gambling and won't sleep well at night if you invest in them, you probably shouldn't.

9. Estimate the amount of time you are willing and likely to spend studying and researching investment options on a weekly basis:

This item has to do with educating yourself about investments so you can make sound judgments in placing your money. You should never make an investment you don't understand clearly or that is really risky, but the more time you spend learning and evaluating investments the higher the level of risk you can tolerate. If you aren't interested and can't make a commitment of time to learning, the investments you choose should tend to be conservative.

10. Estimate the amount of time you are willing and likely to spend per week managing your investments:

This last item has to do with how much time you are actually going to spend keeping track of your investments and making decisions about them, and it's important to be realistic about this issue. Some kinds of investment just require more study and close monitoring than others. So, the more time you know for certain you are willing to devote to monitoring and managing your investments the higher your risk tolerance. The less time you can commit the more conservative your investment choices should be.

Well, that's the exercise. I hope that going through it helped you evaluate and understand some things about your own risk tolerance level. A high level of risk tolerance isn't better than a low level is, and it doesn't mean someone with a higher risk tolerance will do better with their investments than someone whose tolerance level is lower. The intent of the exercise is to help you discover what is right for you.

arley