March 1, 2007, 11:06 am

Risk Tolerance

by: admin    Category: Investment, Market and Risk
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Hello to you, in my previous article, I discussed a few of the essential criterias when you determine what type of investor you are and one of those is your tolerance to risk. It takes several forms and is a lot more important than most investors could ever believe. Many even choose to ignore this aspect despite the fact that it is so critical.

So before skipping this important aspect of investing, please yourself:

-Do you prefer several small losses or one large one?
-Is it even possible that you underestimate the risk in your investments?
-Do you consider risk when looking at each of your investments or by looking at your portfolio as a whole?

One or all of these questions will hopefully have convinced you that risk management is a very important part of your investment. There are generally 4 types of investors:

1. Prudent investor: This investor is scared of investment losses and so usually invests in very safe securities, they often have the habit of overthinking their investment decisions.
2. Methodical investor: Many conservative investors use this method of investment. They have their own investment process are usually difficult to work with as they have high confidence in their own system. They are still more “risk averse” than the average investor.
3. Individual investor: These investors do their own research on opportunities and they are able to form an opinion and agree or not with professionals or financial analysts. They are generally willing to accept a higher level of risk in their investments.
4. Spontaneous investor: These investors are always looking for hot tips, switching strategies often. Because of that, they will suffer losses because of transactions costs for example.

It is also important to distinguish between capacity to take on risks and willingness to do so, this will depend in most part of the following factors:

1. Short and Long terms goals: The proximity in time of the various goals or objectives of the investor
2. The importance of these goals: It is important to determine which goals for example are critical. This would mean that working to obtain other dreams would not have an impact on the critical goals. The most obvious example would be to have a similar quality of life. Many investors are willing to invest and hope to travel and buy luxury items but they are not willing to do so at the expense of risking the possibility of having a lower quality of life.
3. The amount of volatility the portfolio can bear: Considering the invested amount, what degree of risk will be necessary in order to accomplish the goals? Is this degree reasonable or would it put at risk the entire portolio or the goals considered critical?

That’s all for now!

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