May 21, 2007 - You simply can’t have it all. To get a reward, you must be willing to accept some risk. That is the fundamental trade-off of investing, risk is involved with almost any investment. Each investor must establish their own risk-reward profile as the basis for determining how to structure their investments. The first step is to determine the time horizon you have available for your investments to grow and the next step is to assess your ability to accept and absorb risk. It is from this analysis that your rewards may follow:
Step One – What’s Your Expected Time Horizon?
In order to balance both the income and growth levels of your portfolio you will need to allocate your investment assets according to both your level of acceptable risk as well as the amount of time you have available to achieve your goals. Your time horizon is instrumental in determining how you manage risk. The more time you have, the easier it will be for your portfolio to absorb risk. To help determine the time frame you need for your investments, consider the following definitions:
Long-Term Investor – if your time horizon is five years and beyond, then you should consider your self a long-term investor.
Intermediate-Term Investor – if your time horizon is a minimum of two years and a maximum of five years, you should consider your self an intermediate-term investor.
Short-Term Investor – if your time horizon is a period of one to two years, you are definitely a short-term investor.
Step Two – How Well Can You Tolerate Risk?
To answer this question you must ask yourself how much you can afford to lose comfortably within the course of a year and bounce back without irreparably damaging your financial health. If you safely establish your level for risk tolerance then you won’t feel panicked at every bump or blip on your investment portfolio’s radar screen. Ask yourself, what is the worst case scenario for my finances and how much can I afford to lose within a year’s time frame? To help determine your risk profile, consider the following definitions:
High Risk Taker – you are able to withstand and recover from losses up to a maximum of 25% of your portfolio within a given year.
Moderate Risk Taker – you are able to withstand and recover from losses up to a maximum of 15% of your portfolio within a given year.
Low Risk Taker – you are able to withstand and recover from losses up to a maximum of 5% of your portfolio within a given year.
