With inflation still soaring and markets still turbulent, it’s a good time to discuss an important concept: Risk tolerance.
You’ve probably heard those words bandied about when talk turns to investing. But do you know what they mean?
Risk tolerance is generally defined as the ability to stomach large swings in the value of your investment portfolio. Because the market, by nature, is very volatile, understanding your risk tolerance is vital for making prudent decisions.
Here are 3 factors to help you figure out how much risk you can tolerate:
The first factor is time. When will you need the money? Generally, you can take a lot more risk if you’ve got 10-years or more. Any money you’ll need in the next 3-5 years should be in cash. You don’t want to be forced to sell if the market is down.
The second factor is cash reserves. How much cash do you have on hand? If all your money is fully invested, with no extra cash to cover unexpected expenses, that would be a problem, especially if you must sell stock at a loss.
The third factor is sleep. How much volatility can you stand before you start stressing out, unable to sleep at night? We all know what happens if we don’t get enough shut-eye. Everyone suffers!
Those factors are crucial considerations. But keep in mind. Your biggest risk is outliving your money by not outpacing inflation. Stuffing your entire savings in a drawer is like living in a house full of termites. Even if nothing seems awry, you’ll doubtlessly be dealing with costly damages down the line.
How much risk tolerance do you have? Let me know in the comments below.
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