When you're buying stocks and investing your money, how you perceive risks and respond to losses is purely subjective. However, you can gauge your risk tolerance to gain a clearer understanding of the types of investments you feel comfortable with. You can also stretch your comfort zone by adjusting your perspective.
Those who have never experienced financial hardship often become flippant about risk. After all, it’s only money, right? Well, for some rare souls, money is really only money. For the rest, money represents more than that — having good credit, owning a car and a house, supporting a family, and even eating a couple of meals a day. Because of this gravity, realize what’s really at stake before you make any investment.
You don’t want to lose sleep over your investments, so try gauging your risk tolerance in relation to sleepless nights. Use the following guidelines to estimate your comfort level:
High tolerance: You can handle extreme volatility in your investments and the possibility of massive losses, and you’re able to sleep at night when the market is in turmoil.
Average tolerance: You can handle average-sized drops in price for extended periods, but the extreme stuff makes you anxious, jumpy, and unable to sleep at night.
Low tolerance: Losses of 5 percent keep you awake at night. It’s mostly bonds and bank accounts for you.
Don’t risk what you can’t afford to lose. If you’ve saved $20,000 to send your daughter to college next year, investing in stocks, even “safe” stocks recommended by a trusted source, is probably a bad idea. If your share prices drop, you have little or no time to recover from the losses before you need to cash out.