Risk Tolerance is what allows you to sleep at night.
Imagine how you would feel if your Roth IRA had $500,000.00 and you lost 10% in one day. So let’s say on Monday you check your Roth IRA value and you see a big fat $500,000.00 in your account, then on Tuesday you see $450,000.00. You just lost $50,000.00 in one day. Ouch!!
Well, you have to remember that’s the way of the markets. If you can stomach those type of losses and realize that the markets do what they do overtime, go up and down and recognize that they really do go up historically, you’ll be fine. But, that’s a big emotional step for some folks and it takes some getting used to.
It’s also a reason why we have to spread our risk over different asset classes and styles. With mutual funds we want to spread our investments over different asset styles – large growth, large value, small growth, small value, some international, and some…the list goes on and on for the types of investments we can hold.
Asset classes include equities (stocks), bonds, fixed income and cash. Stocks can be held inside mutual funds as well as bonds and fixed income investments. Mutual funds are the way to go for most folks as they work their way through life. Mutual funds allow you to spread your risk over many types, styles or classes of investments to lower your risk while investing your hard-earned money.
Your risk tolerance at age 70 is going to be different than at age 30. A 70 year-old person who’s retired or getting close to retiring will want extremely low risk investments or no risk at all to protect what they do have. A 30 year-old investor might be able to tolerate a lot of risk because there’s plenty of time to recover from any losses they experience in their retirement portfolio.
Take this Risk Tolerance Quiz to get you thinking.