Life is about trade-offs, and so is investing. The investment trade-off is between risk and return. Getting a return on an investment means accepting risk, at least to some extent.
But what, exactly, is risk? And how much of it can you tolerate? To start finding the answers to these questions, let's take a quick look at some key definitions.
- Risk – the probability that the performance of an investment will differ from its expected return
- Risk Tolerance – your ability to handle fluctuations in the market value of your portfolio and your level of comfort with the portfolio's risk
When we talk about the concept of risk, we're focusing on both the possibility that you may lose some money and how comfortable you feel with that possibility. That second part – your comfort level – plays a big role in determining your risk tolerance. Accepting large amounts of risk may not be worth it if your riskiness is keeping you up at night. This is a decision that only you can make, and your decision won't align with all the other investors you know. Some investors may be comfortable with more risk than other investors even if they share the same goals and time horizon, and some people might feel queasy just thinking about another investor's risk tolerance.
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The analytical tools described in this article are for information purposes only and their use does not guarantee a profit. None of the information provided should be considered a recommendation or solicitation to invest in, or liquidate, a particular security or type of security. Investors should fully research any security before making an investment decision.
