If you are starting out on your investment journey, one of the first things you should ask yourself is “How much risk should I take when investing?” Just the word risk may sound scary, especially if you aren’t a huge risk-taker in other areas of your life.
Typically speaking, when it comes to the stock market a higher risk generally means more reward in the long run. This risk-reward concept is what drives the investment strategies of many, but it’s common for some to not understand how to determine the level of risk they should take with their portfolios.
Here’s what to know when determining how much investment risk you should take.
Step 1: Figure Out Your Goals
Your first step is to determine, quantify, and prioritize your investment goals. Ask yourself what is the most important for you in this stage of your life. Do you want to invest so you can save a nest egg for retirement, have an emergency fund, or have something put away for a large purchase like a car or a home? All of these goals have different time frames that require different risk levels.
Step 2: Consider Your Time Horizon and Bankroll
Your time horizon is the amount of time you have to keep your money invested. As a general rule of thumb, the longer you have to keep your funds invested, the bigger your return will be. So you’ll have to consider exactly how long you have to save, and then choose your risks accordingly.
A person’s bankroll is the amount of money they can stand to lose. Understanding how your time horizon and bankroll work together will allow you to make decisions about the risks you can choose.
Step 3: Use the Investment Pyramid For the Most Diversity
The risk pyramid is an asset allocation rule that can help investors diversify their portfolio according to the different risk profiles of each investment. There are three tiers.
The Top of the Pyramid
Reserved for the riskiest investments, these investments should consist only of disposable money you can lose without serious repercussions. Some examples of these investments include high-risk stocks, bonds, and collectibles.
The Middle of the Pyramid
These investments allow for a stable return while allowing for capital appreciation. Examples include real estate, high-income bonds, and equity mutual funds.
The Base of the Pyramid
As the foundation of the pyramid, this portion should include your strongest investments, which are low risk and have foreseeable returns. The majority of your assets should be in this stage, which includes money maker bank accounts, government bonds, and cash and cash equivalents.
Not all investors and investments are considered equal. Your finances are extremely personal, and as an investor, you should completely understand the risk profile you take on. At Second Opinion Partners, we are here to help you plan ahead, manage your finances, and make an individual financial plan relative to your needs.
Give us a call today for more information on how we can help you.