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May 13, 2000
We have received many emails from people who want to know how to go about starting to invest. These emails always ask what we recommend the new investor should invest in. Most times the email sender has not given us any information regarding their investment profile and risk tolerance. With this lack of information, we usually can only give the sender very general information on how to get started.
In this article, I am going to address one of the most important factors to consider when beginning to invest and that is "What is your risk tolerance?" Before anyone should start investing, an assessment of your risk profile is necessary.
- Can you afford to take a complete loss on the money invested?
- Are you investing for the long term or the short term?
- Do you have plans for the money anytime soon?
Can you afford to take a complete loss on the money invested?
The first thing you must ask yourself is "Can I afford any loss or even a complete loss of the money I intend to invest?" There is always the risk that you will lose money on an investment. If you are in your later years, nearing retirement or even in retirement right now and if you can't afford to lose money, you have a low risk profile. You need to structure your investments on the very conservative side. Some investments that might fit your risk profile are: US Treasury Notes, Certificates of Deposits from your savings institution, money markets and perhaps a mutual fund that invests in US government bonds. These types of investments are in the very low risk category. Generally, lower risk investments yield lower returns. Remember even the safest of investments can still yield a loss so be sure you do your research and understand the terms of the investment before you invest.
Are you investing for the long term or the short term?
There is a difference between investing for the long term and creating income for the short term. Today many investors are looking to grow their investment accounts for the short term to create income to increase their lifestyle or for an upcoming purchase they might consider if the money is available. Mutual funds, stocks and options all fit into your risk tolerance. That is if you can emotionally stomach any losses.
Short term investors are usually looking to maximize their investment gains over a short period of time; they also tend to be market timers – trying to reap the rewards out of the short term trend of the market movement. These short term investors have a very high risk tolerance and can afford to take losses and maybe complete losses of investments. The short term investor might consider individual stock issues and possibly trading options. While stocks and options can be moderate to very risky they tend to be very profitable when your investments perform for you.
If you are strictly long term, "thinking for retirement", you probably have a "moderate" risk profile and you should consider highly rated growth and value mutual funds or consider the strong "Blue Chip" stocks. If you are young and your income will continue to increase and you have a regular stream of income you can continue to invest into the market, then your risk tolerance can be higher. Don't forget that retirement portfolios can be divided up and structured to accommodate different levels of risk. Consider consulting with a financial advisor to determine what percentage of your portfolio might be allocated to low risk (i.e., bonds), moderate risk (i.e., mutual funds and blue chip stocks) or high risk investments (i.e., high growth stocks and options).
Do you have plans for the money anytime soon?
If you are planning to use your investment money anytime in the near future for a house, a car, funding a college education or something else, you probably can't afford to lose any of the principal or very little of it. You would fall into the low risk category. Of course, if your time frame has some flexibility, you might be able to raise your risk profile a little to gain greater returns. Like the investor who can't afford any losses, investments for your low risk profile are: US Treasury Notes, Certificates of Deposits from your savings institution, money markets and perhaps a mutual fund that invests in US government bonds. Don't be fooled by the lure of the roaring market and invest your money in a "can't lose" mutual fund or a "can't lose" stock. All investments have a risk of loss and mutual fund and stocks can reverse trend on any day with bad news.
As you can see, assess one's risk profile can be very complicated. Even though it can be a chore, it is a necessary step before beginning to invest. Don't just jump into the market roller coaster without knowing if you can afford the ride.
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