In the past several columns, we have been discussing putting price tags on each of your long-term financial goals, so you can reduce those to a monthly price tag just like your home or car payments. In this column, we are going discuss investment philosophies.
Your risk tolerance
This column is not designed to offer advice as to which investments are best. Instead, I will cover several investment philosophies that should help you find your way through the investment maze.
A good first step before making any investments is to understand how much of a risk taker you are. The test below has been designed to help you determine where you fall on the risk tolerance scale.
The value of understanding your propensity for risk is the same as understanding any aspect of your personality. Knowing that you have a tendency for jealousy, for example, does not mean you should never put yourself in a position where you might feel jealous. It means that whenever those feelings occur you know it is normal for you – it is a part of how you are wired. It does not mean you will never feel jealous. It simply gives you some degree of freedom to feel that way and continue with whatever you are doing.
The same is true with investment risk. If you are to achieve financial success, even if you are very conservative, you will have to put your money in places where it can be productive; and sometimes that may feel risky.
Similarly, if you are a gambler, you may have to force yourself to use some restraint, especially when pursuing short-term goals. That may feel boring, but it is usually not wise to take excessive risks when you do not have the time to ride out financial downturns.
Your risk-tolerance factor
Dorothy W., a 61-year-old widow, lies awake nights worrying about how she is going to manage when she retired. With limited savings, a small company pension and Social Security, her retirement income would be meager indeed.
Therefore, in a moment of panic she invested her available cash in a limited real estate partnership a friend mentioned. If she is lucky, the investment will pay off and improve her financial situation.
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However, Dorothy still lies awake. Now, she worries about her investment; knowing the risks associated with it. If she lost a portion of it, that would mean she would have even less to live on in retirement than originally expected.
Are you a play-it-safe investor? Or, are you willing to take a few risks for a potentially greater financial gain? The short quiz below will help you decide what propensity you have for risk tolerance.
- On a trip to Las Vegas, you lose $150 playing the slot machines. You:
a. Get another $50 worth of quarters, hoping to recoup part of your loss.
b. Go sightseeing and forgo the casino.
c. Keep playing, but plan to stop when you have lost another $150.
- The aphorism that best describes your attitude toward life is:
a. The early bird catches the worm.
b. No pain; No gain.
c. A bird in the hand is worth two in the bush.
- A friend who is a stockbroker calls with a hot tip. You are most likely to:
a. Say you are not interested.
b. Pull out your checkbook.
c. Ask for more information.
- You park most of your cash in:
a. Money market funds.
b. Bank savings accounts.
c. Certificates of deposit.
- You win a contest sponsored by your local radio station and have a choice of three prizes. You take:
a. An all-expenses paid trip to a resort.
b. $1,000 in cash.
c. 100 shares of stock in the radio station.
- You spend a rainy Sunday afternoon with:
c. A crossword puzzle book.
- Your son persuades you to buy stock he says is a winner, but three months later you have lost $1,000. You:
a. Sell the stock and cut your losses.
b. Do nothing and hope the price will rise again.
c. Buy more shares (the price is so low!).
- You are thinking about buying a house in Florida to rent out, then eventually retire to. You tell the real estate agent to look for:
a. A large house that needs some work in a good neighborhood.
b. A small, well-maintained house in an established neighborhood.
c. A large house located in an up-and-coming neighborhood.
- You have developed a way to take the calories out of cakes and cookies without affecting the taste. You:
a. Sell the patent to General Foods for $1 million.
b. Try to raise the money to setup a company to produce the new product.
c. Accept a position with General Foods managing the division that markets the new product.
- Your attitude toward managing your pension money is:
a. I want my investments to grow faster than inflation.
b. Beating inflation is less important than preserving income and capital.
c. I will risk some income for a chance to beat inflation.
- The bill for your weekly groceries comes to $285, and you have $300 in your wallet. You pay for the groceries with:
a. A check.
c. A credit card.
- You would put a $75,000 pension plan lump-sum payout into:
a. A mutual fund that invests in government securities.
b. A high-yield certificate of deposit in a shaky Savings and Loan.
c. A blue-chip stock fund.
- On a cross-country trip, you would eat lunch in:
a. A restaurant recommended by the guidebook.
b. A restaurant belonging to a national chain.
c. A place the locals say is the best in town.
Now add up your score using the scoring key provided below. The top row of number across represents each question’s number and the letters down the left side represent your answers.
If you scored below 19, you are conservative by nature. If you scored between 20 to 32, you are willing to take a chance or two. If you scored 33 or more, you are aggressive by nature. Remember, you should try to select investments that fall within your personal risk tolerance level so you do not lose sleep over them.
The above quiz is reprinted from “Financial Success: A Guidebook to Your Financial Future” by Joseph Tallal with permission from Carole Gould.