Are You a Risk Taker?
Years ago I heard Steve Forbes, the publisher of Forbes Magazine, say “everyone is a disciplined, long-term investor until the market goes down.”
When it comes to investing there are definitely some investments that are riskier than others. How do you know which investments to jump on and which ones to give a pass? It’s common for investors to make the mistake of not matching their investments with their overall objectives. It can be hard to gauge if the risk is worth the potential payout, or if you should use something with little less risk.
Financial planners use different methods to help clients understand the types of investments they should be looking into. A risk profile is one tool that gives insight into your ability and disposition towards taking on financial risks. It aids in determining the proper investments or portfolios to invest in; it can align investors with the appropriate level of risk associated with their personal goals. For example, some investments come with a much higher risk, which can produce fantastic returns, but also come with potential for financial loss. On the other hand, there are investments that carry a much lower risk, but produce a much lower return as well.
When we look at risk we can see it as a balanced scale. If you place higher risk on one side, the other side is typically balanced out with a higher payout. If you place lower risk on the scale, the other side will have a lower payout to keep it balanced. There are several types of investment risks, and some can be managed, but perhaps that is an article for a different day.
The most common way to discover your risk profile is through a Risk Profile Questionnaire. It’s like a financial personality quiz that reveals a person's ability or willingness to take risks. It consists of questions that measure your attitude and understanding of financial markets. It also helps gauge how you might react to certain investment scenarios. Your responses are calculated to determine your risk level. The results are used to develop a portfolio.
Once you know your risk profile, it’s helpful to revisit these questionnaires regularly because a person’s risk profile changes over time. This is helpful in maintaining an alignment with your investment goals.
Typically there are five types of investors. The score you receive from the Risk Profile Questionnaire will determine which type of investor you are.
A conservative investor’s focus is on protecting principal instead of seeking higher returns. They are comfortable accepting lower returns for a higher level of security and more liquidity of their investments. Overall, a conservative investor minimizes risk of loss.
A moderate-conservative investor’s objective is principal preservation, but is comfortable accepting a small degree of risk to seek some degree of appreciation. This investor is willing to accept lower returns, and is willing to accept minimal losses.
A moderate investor permits some risks in order to enhance returns.
They are prepared to accept modest risks to seek higher long-term returns. A moderate investor can endure a short-term loss for the trade-off of long-term appreciation.
A moderate-aggressive investor places a higher value on long-term returns and is willing to accept significant risk. This investor believes higher long-term returns are more important than protecting principal. A Moderately-Aggressive investor may endure large losses in favor of potentially higher long-term returns.
An aggressive investor prizes profitability and is willing to accept substantial risk. This investor believes maximizing long-term returns is more important than protecting principal. An Aggressive investor may endure extensive volatility and significant losses.
Knowing your personal risk tolerance gives you an understanding of what’s important to you, as an investor, and will guide you to make decisions that reflect your overall goals. It is hard to classify as a moderate risk investor, and expect to “beat the market”, and then be upset at times when your account goes in a negative direction. Investors can’t have it both ways.
If you want to complete a risk profile questionnaire, you can do so here, it takes about five minutes and you will receive your score in your email.
“The only people who never get criticized are those who never do anything.”
Pg. 132 The Maxims of Wall Street by Mark Skousen