As a rookie investor, how much risk can you tolerate? This is an important question as the answer helps you make the right investment choices.
Before you know the level of your risk tolerance, it is important to understand the nature of investment risk, the likelihood of occurrence of losses relative to the expected return on any investment.
This risk is especially prevalent when you invest in stocks because stock prices will always fluctuate – and there are never any guarantees about performance.
Of course, depreciation in value does not mean you need to sell, you can hold on to the stock with the hope that its value will rebound. And this can certainly happen, but again, it is not 100 percent assured.
How you respond to this type of investment risk will tell you a great deal about your own risk tolerance. Of course, no one with a high tolerance for risk, or a low one, will like to see lose money on his or her investment.
If you are the sort of person who can retain your confidence in your investment mix and can focus on the long-term and the potentials for recovery, you may well have a higher tolerance for risk.
On the other hand, if you find yourself losing sleep over your losses and in despair about reaching your goals, and questioning whether you should be investing at all, then you may have a low tolerance for risk.
This self-knowledge of your own risk tolerance should help inform your investment decisions to a point.
Even if you feel you have high tolerance risk, you almost certainly should not load up your portfolio exclusively with stocks because if the stock market enters a prolonged slump just as seen in the Nigeria equities market, you could face heavy losses that may take many years to overcome, causing you to lose significant ground in the pursuit of your financial goals.
Conversely, even if you discover you don’t have much tolerance for risk, you may invest in risk-free securities such as treasury bills, Federal Government savings bonds, and sovereign notes. It is also important to weigh the returns on these securities with the current inflation rate to avoid losing purchasing power.
Ultimately, then, you will probably want to let your risk tolerance guide your investment choices – but not dictate them with an “iron hand”. So if you believe you are highly tolerant, you might have a somewhat higher percentage of stocks in your portfolio than if you felt yourself to be highly risk-averse.
But in any case, you will likely benefit from building a diversified portfolio containing stocks, bonds, government securities, and other investment. While this type of diversification can’t guarantee profits or protect against losses, it can help reduce the effects of volatility on your portfolio.
By knowing your own risk tolerance, and the role it can play in your choices, you can play in your choices, you can help yourself create an effective investment strategy – one that you can live with for a long time and that can help avoid the biggest risk of all – not reaching your investment goals.
