As you can probably tell, aggressive investors have a chance of being hurt by taking too much risk. If they are investing for their child's college education and lose a large portion in aggressive investments, they can find themselves in a bind when those tuition bills start coming. But it's not only aggressive investors that can be hurt; conservative investors can also be hurt by investing too conservatively. They may feel that they don't want to risk any of their money so they keep their savings in cash, bonds, and CD's. Over time, inflation will slowly eat away at their gains and they might realize when retirement comes around that they should have invested more aggressively in order to reach their goals.
But how do you decide how much risk you should take when deciding on your investments? It really comes down to a few simple ways to help you decide.
Personality
Your personality isn't just a way of characterizing yourself compared to others, but it can also help you determe the amount of risk that you should be taking. If you're the type of investor who doesn't fear market declines, you might want to take a more aggressive approach.
But many investors out there worry about their investments constantly. If you find that you are an investor like this, perhaps you should take a slightly more conservative approach. This should help save you a few sleepless nights and allow you to relax more without worrying about your investments.
The Three Questions
Although your personality plays a large role in deciding on what risks to take, the largest role is played by how you answer these three questions.
- What is my investment objective? - This question is meant for you to determine what you are saving for. Perhaps it is a new car, a down-payment on a house, or your own retirement.
- How long will I be investing for? - This is a question that you ask yourself to determine your time-frame for investment horizon. If you are investing for that new house that you and your wife (or husband) plan to buy next year, you would probably want to keep your investments a little safer because if you lose any money, it would be hard to make it back up by then. But if your goals are a long time away (such as retirement), you might want to be more aggressive to maximize your gains and then your portfolio allocation to more conservative investments as that goal nears.
- How much do I plan to save? - If you plan to save a lot, you might want to take a more aggressive approach. This will help you by allowing your investments to compound a little easier and make your goal an attainable one. But if you don't plan to save a whole lot of money to reach your objective, you can usually take a conservative approach.
All investments have risks, even so-called "risk free" investments like bonds and CD's. Some investments are riskier than others so it is very important to know how each one is classified. Here is a chart to help you decide on your current portfolio risk.
High Risk
-Futures, options, and other derivatives
-Internet stocks
-Mining and precious metals
-Low-rated bonds
Moderate Risk
-Growth stocks
-Small-cap stocks
-Real estate
-Medium-rated corporate and municipal bonds
Limited Risk
-Income stocks
-Blue chip stocks
-Balanced mutual funds
-US Treasury bonds
-High-rated corporate and municipal bonds
Low Risk
-Savings and checking accounts
-CD's
-US Treasury Bills
-Money market accounts
Now that you have an understanding of risks involved with investing and what risks you should be taking and which ones to avoid, you might want to re-evaluate your portfolio. Perhaps a few small changes will help in the long-term by making you a very wealthy Buck investor.