How Much Risk Is Too Much Risk? (What To Look Out For In Your Investments)

How Much Risk Is Too Much Risk? Aikido Finance

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Introduction

You’ve made the decision to invest your money into stocks and bonds at the height of a financial slowdown. You have researched, planned, and made the calculations, and now you’re beside yourself with anticipation and excitement. This is pretty much what the investor’s path looks like; everybody who embarks on it will find themselves in a situation where they take risks.

But, 

‘How much risk is too much risk?’ 

This is a common question you may have already heard and one that has no easy answer. Here’s a hard truth: every investment entails some level of risk. Market circumstances may deteriorate, stocks and bonds may lose value, perhaps all of their value. Inflation risk exists even in conservative, guaranteed investments like bank or credit union certificates of deposit (CDs).  So, if you take on too much risk, you may suffer the consequences of volatility, while taking on too little risk may not provide you with the returns you desire.

You can begin your own Long Term Investment Portfolios, with pre-made quantitative strategies available on the Aikido Finance website along with rebalancing services available later this year.

What is the Risk?

Risk is a term used in finance to describe the degree of uncertainty or potential financial loss associated with a financial decision. 

Types of Risks Investors Face

1. Business Risk

Whenever you purchase a stock or bond, your returns on each of these investments are contingent on the issuing company’s continued existence. When the firm declares bankruptcy and liquidates its assets, ordinary stockholders like you are the last to receive a part of the revenues. 

The same logic applies to bonds. If the corporation holds assets of this nature, the bondholders will be paid first.

Before buying an annuity, think about the financial strength of the organization offering the annuity. You want to know that the company will still be around and financially strong during the payout phase.

2. Inflation risk

Inflation diminishes purchasing power, posing a risk to investors who are paid a fixed rate of interest. If you have invested in cash equivalents, you should be most concerned about inflation eroding returns.

3. Interest rate risk

The value of a bond can be affected by changes in interest rates. Investors will be more interested in freshly issued bonds as interest rates rise. You may have to sell an older bond with a lower interest rate at a discount if you want to sell it. The bond may be worth more or less than the face value if sold before maturity.

4. Liquidity risk 

There is a risk that you will not sell your investment at a reasonable price or withdraw your funds when you need them because there is no market. Some assets, such as exempt market investments, may not be able to be sold at all. This is especially true with increasingly complex investment solutions.  It could also be the case with goods like certificates of deposit with a penalty for early withdrawal or liquidation (CD).

5.Volatility risk

Even though a company isn’t at risk of going bankrupt, its stock price can go up and down. Large firm equities, for instance, have lost money approximately one out of every three years on average. A stock’s price can be influenced by issues within the firm, such as a faulty product, or circumstances beyond the company’s control, such as a natural disaster. Market volatility can be unsettling.

How to determine the amount of risk you can take

There are three main factors to consider when determining how much risk is too much risk to take.

Goal for investment 

First and foremost, it is crucial to determine, measure, and define your investment goal. This is a crucial step because investment strategies such as down payment on a house or planning for retirement have varied time spans that demand varying risk levels. For example, if you’re 20 years today and planning for retirement, you have more than four decades to work with, so you don’t have to be concerned about short-term fluctuations. 

But if you’re 50 and still hope to send your child to Harvard University in a few years, you shouldn’t take needless risks with money set aside for that purpose. 

Goal setting necessitates answering key questions such as;

  • When will I retire?
  • How much annual income would I require?
  • Should I make a down payment for a car, and if so, when and for how much?
  •  Should I send my child to an international school, and if so, when and for how much?

 You must then prioritize these goals and set aside a set amount of money to save for them. 

Assess your risk capacity 

Do you enjoy taking risks? Some people are simply risk-takers by nature, and it’s perfectly fine for their financial portfolios to reflect that. But if the thought of a $50 loss gives you the creeps, you should probably lower your risk level a notch or two.

Age

The single most essential component in evaluating risk tolerance is your age. If you are about 30 years today, you can afford to take on more risk in your pursuit of long-term gains.

Reason?

You have almost 30 years before retirement. In contrast, if you are 50 years old right now, then it is obvious that you will need retirement money in a few years, and you simply should not take the risk of long-term investments.  

What risk means for you 

Investors that wish to succeed in investment understand that risk is an integral component of the process. There are a variety of things that you may do to alter the amount of risk you can handle, but the good news is that you are capable of dealing with a particular level of risk. The key to using risk to obtain what you want out of your investment is understanding the role that risk plays in the process.

The bottom line? 

“How much risk is too much risk for an investor?” is a question that has no clear answer. 

The best strategy for you is to come up with a risk level that is unique to you and then choose your assets based on that risk level. There is no such thing as a “one-size-fits-all” solution.

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