We’re told it’s good to take risks early in life, but does this advice hold up when it comes to investing? There’s no short answer except: It depends. The truth is that it comes down to who you are and what you want. I’ll explain.
In the investing world, risk is the probability that you will experience financial losses. The benefit of taking risk, however, is that it can come hand in hand with higher returns, or profit on your investments, in the long run. If you’re trying to figure out how much risk to take, first consider these two questions:
1. What is your financial situation?
It is crucial to determine your risk tolerance before you start investing. How much risk you should take depends on both your 1) willingness and 2) ability to accept risk.
Your willingness to tolerate risk is your subjective attitude toward risk taking. In other words: What qualitative emotions do you have around investing? At Moka for example, we ask questions like “Imagine your stocks are down. How would you react?” Your answer gives us a good sense of how willing you are to take risk, and this knowledge helps us invest your money accordingly.
Your ability to take risk is equally important. Before deciding how much risk to take, you should also look at quantitative factors like your income and your net worth. If you have a high income and net worth, you can afford to ride out short term losses and emerge with healthy finances in the long run. Someone with a lower income or net worth simply can’t afford to lose so much.
2. What are your financial goals?
Identifying a goal before you start investing is important. Your goal helps determine how much risk you should take because it points to your investment time horizon, or the length of time you want to invest before reaching your goal.
Historically, stock markets have seen the best returns on investments over time when compared to investing in bonds or leaving your money in savings. However, the road to profit can be long and bumpy. Over a short time period, it’s possible that your investments may not perform well and you could even see a loss. Fluctuations in the market mean that you’re better off taking less risk if you have a short-term goal. However, if you’re saving for a long-term goal like retirement, you can afford to take more risk because you have time to recover from a hiccup in market performance. You’ll still see profit if your investments have a general upward trend over the long run.
For many millennials, saving for short-term goals is a bigger priority than long-term savings. If you’re looking to achieve a goal soon, taking a lot of risk may leave you disappointed. Imagine you’re trying to save a down payment so you can buy a house in the next few years. If you invest in a high risk portfolio and the stock market takes a major downturn, you could see your down payment shrink and end up further away from your goal. The same principle applies to other short-term goals, like buying a car, taking a vacation or repaying debt.
Bottom line: Consider your financial situation and your current goals before you make a risky decision, or enlist the help of a professional portfolio manager who can design a portfolio that works for you.