The Importance of Investment Risk Tolerance

Whether you manage your own assets or work with a financial advisor, you have probably heard about investment risk tolerance. By definition, risk tolerance is "The degree of uncertainty that an investor can handle in regard to a negative change in the value of his or her portfolio" (Risk tolerance, 2010).

In other words, risk tolerance is a measure of how much you are able to sacrifice when the business goes down. Majority of Americans learned what their true risk tolerance way back in 2008 --- not the ideal way to find out.

One way to learn your risk tolerance is to answer a questionnaire. You can use one online or at a financial professional's office. There is no generic questionnaire, but they all have very similar questions, like:

• When do you need this money?
• What is your investment objective?
• What is your net worth?

You don't have to worryWorry not because, there are multiple choices and are most of the time not that many. You will be categorized according to the result of your answers.There are 3 basic levels of risk tolerance: conservative, moderate and aggressive.

However, the often used chart includes moderately conservative and moderately aggressive risk tolerance as well. It is important to know your risk tolerance because it is the very foundation of putting up a personalized investment portfolio. Differences in risk tolerance results to different combination of fixed and equity investments as well as growth and value investments within a given portfolio.

Conservative investors have the lowest risk tolerance; since they choose not to squander any money or to lose very little. Clearly they are also open to settle for a lower earnings. They stay with investments with assured rates of return such as money market accounts, CDs and bonds with little exposure to stocks. The common combination of fixed and equity investments in a conservative portfolio is 80/20.

Moderate investors can manage some dangers; they either have a lot of time before they need the money or they have plenty of assets to make up for the losses. Usually moderate portfolios require around 50/50 combination of resources.

Aggressive investors can manage the most risk because of their dreams of getting rich. They often have high net worth and can invest in huge things as real estate investment trusts, unit investment trusts, limited partnerships and other investment vehicles unavailable to regular American. The most common fixed-equity investment combination in an aggressive portfolio is 20/80. Some investors are even 100% in the market.

Before investing, make sure to know your risk tolerance and come up with an appropriate investment allocation for your portfolio. If you are a conventional one, a wrong distribution will have you stressed out and panicky about losses. If you are a moderately aggressive or an aggressive player, an overly conservative portfolio will leave you unsatisfied with returns.