Before you begin building your portfolio, you need to determine whether you're a high-risk or low-risk investor. This distinction is incredibly important, not only for financial reasons but also psychological ones. Here are a few things you need to know.
What Are Low-Risk or High-Risk Investments?
In terms of a balanced portfolio, risk often refers to the volatility of investments. Bonds are one of the lowest risk options; you know you'll make a certain amount every year, even though that amount isn't very much. Stocks are high-risk options; you can make a lot or nothing at all, and year-over-year they may be up or down.
Low-risk investments make less money while high-risk investments make more. But low-risk investments are nearly guaranteed to perform at a specific rate, whereas high-risk investments are not.
When Are You Going to Retire?
When balancing your portfolio for risk, one of the major considerations is whether you are going to be pulling out your money sooner or later. If you're young and investing for your retirement, you can withstand greater levels of risk. Over time, this risk will often average out to an improved amount of profit; though the stock market is volatile year-over-year, it's generally not volatile decade-over-decade.
If you're going to retire soon, however, you need to pull back on your high-risk investments because you need your money to be there when you want it. Over time, you'll usually adjust your portfolio to shift your high-risk investments over to lower risk ones, as you approach the age of retirement. This approach allows you to benefit from high-risk investments when it matters more (at the beginning) and low-risk investments when you need security and stability.
What Is Your Risk Tolerance?
Investing isn't all about numbers; it's all about emotions. If you're the type of person who might stay up all night because the stock market crashed, then high-risk investments may not be for you. You may be tempted to pull out of the market at the wrong time or to invest emotionally due to losses.
If you're extremely risk-tolerant, high-risk investments may be the way to go, as you'll be able to approach them analytically. There's nothing wrong with being naturally low-risk or high-risk; the important thing is being able to identify your own unique level of risk tolerance.
Your financial planning adviser can often give you a test to identify your level of risk tolerance as well as your personal financial goals. From there, you can balance a portfolio that is uniquely well-suited to the amount of risk you desire.