There’s no one right way to invest. Instead, it’s about finding the balance between the amount of risk you’re comfortable with and the needs of your future. But just because it’s about being comfortable doesn’t mean that you need to be complacent. You can use a lot more vectors than just your gut instinct when determining your risk tolerance.
Currency vs. Purchasing Power
Does it matter more how much money you have or how much value that money has at the moment? That’s going to affect your tolerance levels. Would you rather lose raw capital or lose the value of your dollar? Maintaining the latter means keeping up with inflation. You should aim for at least 1.6% growth if you want to keep pace, and here’s where the risk factor comes in.
The higher the interest rates offered, the more risky an investment is going to be. But you also need to understand how easy it is to liquidize an asset. Speculative assets might not be that easy to turn into actual cash, which can be a particularly significant problem if you’re dipping into potential spending, living, or retirement money for your investments.
Your Maximum Acceptable Loss
How much are you willing to lose on your investment? You should never invest in a risk without the potential for a suitable reward. You need to consider how likely an investment is to bottom out, but you also need to look at how much you can afford to lose. Investors with significantly more disposable income can handle a more significant loss. You have to consider not just the short and long term trends in a particular investment but also how bad things could be if there were a severe market decline that could affect multiple investments. Consider your acceptable loss across your whole portfolio instead of just on an asset by asset basis.
Diversifying your portfolio is probably the easiest way to reduce your risk, but there’s a ceiling to the benefit. In applying your risk, a portfolio with at least 20 investments is going to provide you with a maximum amount of risk. That means that how diverse you want to make your portfolio between a solid 20 investments is really up to you.
However much you have invested, your appetite will come down to matters of personal risk acceptance. Consider which stocks will keep you up at night, and put a lot of consideration into how much money you’re willing to put at risk. If you find yourself checking your investments daily or are losing sleep thinking about your investments, it may be time for you to start looking at ways to minimize your risk.