If you're puzzled in how to honestly respond, you're not alone. Most people find out their true comfort with risk only after the fact--after they've lost money. Then, and only then, do they really know how much they can financially and emotionally afford to lose.
Your risk tolerance is your ability to make decisions, trading the known for the unknown, and to be comfortable with the decision once it is made.
Before you can begin to understand how to gauge your comfort level in taking risks with your finances and investments, think about how you feel in general about giving up something you know now without being certain of what your return will be in the future. The possibility exists that what you get will be less than your investment.
There are several reasons that risk is mystifying and elusive:
Tolerance for risk is difficult for most people to accurately gauge because it is a socially desirable trait, at least in the United States. The USA was founded by brave individuals who risked their lives and ventured into an unknown land for a greater sense of freedom and independence. Ever since, entrepreneurial behavior has been revered and rewarded. So, people like to believe that they're higher risk takers than they truly are. They want to believe that they'd step up to the plate if they saw an opportunity for significant financial gain..
The truth is that most people would rather not gamble and take the financial risk because they would regret the potential loss in the process. They are not certain they will reap a just reward for the risk they'd take.
When you search your minds and hearts for your own sense of what risk means to you and how much risk you can comfortably tolerate, keep in mind that you, too, may be swayed by what you'd like to believe. Ask yourself how much money you can financially afford to lose. And then ask an equally important question--how much can you emotionally afford to lose? How will you weather the financial and emotional loss?
So what's beneficial? Should you aspire to be a low, medium or high risk-taker? There's no right answer or one-size fits all when risk-taking is involved.
Here are some guidelines that may help you in trying to gauge what's appropriate for you in achieving your goals and objectives:
- Impulsive risk-taking usually pays off with buyers or sellers remorse.
- Calculated risk is always the preferred strategy and surest bet to make.
- Don't risk more than you can financially or emotionally afford to lose.
- Look at what you may lose from risking as well as what you may gain.
- Experimenting with risk is more costly with age.
You can increase your comfort level with risk slowly and consistently over time--taking small but consistent steps which will eventually lead to bigger gains than a one-time gamble on the risky move paying off. Your confidence in yourself will also increase in the process if you succeed over time.
Take a look at this brief video with three financial advisers describing how they speak to their clients about risk and how to gauge what it means to them.
Stay tuned for Part 2 of "Gauging Risk" by understanding the money personality traits which play a big part in how you relate to risk.