In this lesson you will learn 💸
- How risk and return relate in the financial world
- The difference between a conservative, moderate, or aggressive investor
What is risk?
You know what risk is in real life. It’s a situation involving exposure to danger. Why would anyone take risks? Because of the rush it gives them in return. It’s the same with investments. The higher the risk, the higher the expected return – with the important caveat that there’s no guarantee of this. That’s the risk.
Let’s say...
You wanted to invest for your retirement. You could put your money into a savings account and generate very little, if any, return. You could opt for a medium risk investment and, hopefully, fare better or you could take a high-risk strategy and pray that the money you recoup (your ‘return’) is more than you would have got with a less risky strategy.
What determines your personal risk tolerance?
So you know the risks of taking risks, but what about you? How brave or cautious are you? This is what’s known as your "risk tolerance".
Risk tolerance is influenced by:
- Your personal situation and circumstances: the less money you have, the less risk you can afford
- Your emotional predisposition: your money mindset and how well you'll cope with the ups and downs
What type of an investor are you?
When translated into investing, there are broadly speaking three different types of investors:
- Conservative: are wary of any type of risk that could jeopardise their savings
- Moderate: aim to follow a balanced approach, assume some risk for the expectation of a return
- Growth oriented: tend to be market-savvy, using their knowledge to target maximum returns
Your action 📝
How about putting it to the test by going through a dedicated questionnaire for financial personality test?
- Take one of the many online investment tools, most of them, if not all, will ask you some questions up front when opening a demo account - that is the so called risk assessment. You can take it without having to open or fund the account.
- Use one of the free online risk assessment tools, we liked the University of Missouri online Investment Risk Tolerance Assessment or the risk tolerance calculator by CalcXML, both are free to use.
Discover more
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What are stocks, bonds and co?