Today's Chemist at Work
May 1999
Today's Chemist at Work, 1999, 8(5), 47-48, 50.
Copyright © ; 1999 by the American Chemical Society.

What's Your Investment Risk Tolerance?

Have you ever heard that you should choose an investment strategy based on your financial goals and length of time before the realization of those goals? That is good advice, but there is another factor you should consider in building your investment portfolio. Itís called your "risk tolerance," and your awareness of it can make or break your financial success.

Why is knowing your tolerance for investment risk so important? If securities such as stocks are not right for your objectives, then you will not be happy if you unload them in a panic when the market gets bumpy or if you cannot sleep at night because you are worried about losing money.

Following is a short quiz that will help you learn how tolerant of risk you are, with a few interpretive comments after each question. Such insight can help you choose a mix of investments suitable for both your financial goals and your temperament.

If you find that your risk tolerance is low but your goals require a more aggressive stance, consider that, generally, the risk of losing money in some stocks over the long term has paled in comparison with the risk of losing buying power to inflation in more conservative investments. Supposedly "safer" investments carry a real risk of their own.

How long until you'll need at least some of the money from your investments?
box   1-5 years
box   5-10 years
box   More than 10 years
The length of time you can hold an investment largely determines how much risk you should tolerate. Stocks may be risky for periods of less than five years because the market might not have enough time to recover from a downturn. Historically, the longer the holding period for stocks, the less chance investors have had of losing money.

Imagine that you buy shares of a stock fund, and three months later, the share price jumps up 30%. Which would you do?
box   Sell the fund and lock in your profit
box   Hold on and hope for a rebound
box   Buy more shares
Those who chose to take the profit after three months are probably less risk tolerant, while the more aggressive investors would hold on for further gains or even add to their holdings.

Say you buy the same stock fund, and instead of its price rising, it plummets 30% after three months. Now what would you do?
box   Sell to avoid further losses
box   Hold on and hope for a rebound
box   Buy more shares at the new lower price
The stock market heads downward occasionally, and that's not the best time to gauge your risk tolerance. If you opted to sell at a loss, explore your risk aversion further, and don't buy securities you won't be able to hold through volatile times.

Take the same situation as in the previous question, but this time the fund is part of a portfolio you won't need until retirement in 15 years. What would you do?
box   Sell
box   Hold on
box   Buy more shares
A longer time frame and a more diversified portfolio make many investors more comfortable during downturns. If you still choose "sell" here, consider learning more about all types of risk (including inflation risk) and how you can manage it more comfortably. By "holding on," you are staying the course in hopes that the market will rebound and place your investments in a better position over the long term.

Return to article