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When you first start investing, it is important to carefully evaluate your risk tolerance. Risk tolerance is the amount of risk you can stand for your investment portfolio. It is important to understand this factor, as it will help you decide what kind of investments to make, and help you better manage your investment portfolio.
Financial risk tolerance
Knowing your financial risk tolerance is vital. You should never invest money that you need. Investment money should be money that is available for loss, if necessary. Financial risk tolerance takes into account how much you can afford to invest, and it accounts for how much you can afford to lose (if it comes to that — and it might).
Another thing it takes into account is how long you have to make money. If you have a long time (such as your retirement portfolio), then you can tolerate investments with higher risk. If you don't have a lot of time, it is time to start to re-balance your investment portfolio so that it settles down to a steady income (and hopefully one that beats inflation).
If you want to make money fast, and have the financial tolerance for it, high risk investments or a foray into day trading may be appropriate. If you have a large goal in mind, that is further down the road, mixing in some safer, solid earners is a good idea. Know your financial situation and your goals before you start investing. This will help you figure what is best for you financially.
Emotional risk tolerance
This isn't thought of much when investing, but it is still important. You need to evaluate how much risk you can stand emotionally. Some investors can take a lot of risk. They are excited by it, and they trade often. Day traders often have a high emotional risk tolerance.
Other investors, though, have a lower emotional risk tolerance. Investing makes them anxious. They worry about losing the money. In such cases, it is important to look into solid earners and investments. Index funds work well for those with low emotional risk tolerance. Those who feel anxiety over their investments should look for solid decisions that they can “set and forget” — checking in every couple of months on how the investment portfolio is doing.
Knowing both of these factors can help you make better investment decisions for your situation.
Disclaimer: I am not an investment professional. This should not be construed as investment advice. All investment carries the risk of loss. Before investing, do your own research and/or consult with an investment professional.
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