Risk 101: What’s Your Risk Tolerance?

Singapore investor Peter Lim and Hyflux’s Olivia Lum are on opposite sides of the investment risk spectrum.

One-time stockbroker Lim is known to make astute moves into diverse industries from agribusiness to fashion, and more recently has a penchant for buying up motorsports assets and top football teams. Lum is famously known for driving around on a motorbike selling her water filter and treatment products and pumping all profits back into the company. While both the investor and entrepreneur have succeeded, the historical odds are on Lum’s more conservative investment approach.

Olivia Lum’s conservative risk profile is behind her rise from an impoverished orphan to one of the most successful business woman in Asia. Women are three times more likely to succeed in a business than men because they take small, calculated rather than big and bold risks. This same approach to risk can improve your investment performance.

Risk Tolerance

Risk tolerance is the degree of change in the value of your investments you can withstand. While risk tolerance is typically a financial measure, your emotional risk tolerance also affects your investment performance. If you are stressed over taking on high investment risk, you are more likely to make bad decisions on when and what investments to buy and sell. Once your risk tolerance is determined, you will be able to develop an asset allocation strategy that suits your risk profile and investment objectives.

Risk tolerance is measured on a continuum ranging from Conservative to Aggressive. The highest risk tolerance profile is associated with males, professionally employed, educated, financially literate and married.

Determining Your Risk Tolerance

On a life spectrum, risk tolerance is highest for young, established professionals and lowest for someone in retirement. If you are a young professional saving for your first house, you will want to make conservative investments. If you are mid-career, have paid off your house, seen the kids through college and are earning six figures, you can allocate more money to higher risk, higher return investments.

Following are key considerations you should include in any risk tolerance assessment.

Investment Time Horizon – Your age and investment objectives will determine the time horizon of your investments. The most important questions to ask are, when will you need the money and for how long? If you are 25 and plan on retiring when you are 65, you will be able to take on more aggressive, higher growth investments than a 45-year-old investor retiring at age 65. Many retirement investors will put some money in bonds to beat inflation and taxes, while cash in the bank, money market funds and CDs are safe low-yielding havens.

Investment Objectives – Most investors seek to provide a financial cushion for retirement. Young professionals seeking to put four kids through college in 15 years may seek a moderate investment approach, placing some money in high growth stocks that will beat the S&P but still maintaining a high weighting in cash, bonds and other reliable, annual dividend yielding investments.

Life Stage – The traditional retirement age is changing. More 60 year olds want to and are working until they are 80-plus. While some 30 year olds seek a high-growth investment style to support the goal of retiring at the young age of 55.  This investor may place more money in REITs than bonds. REITS have returned 9.5% to Singapore investors versus 8.5% for the average investor in 2014.

Future Earning Capacity – How much income will you need? This calculation includes current earning capacity, potential future earning capacity and potential loss of future earning capacity. The analysis should include the forecasted demand and earnings for your profession. Any illness or condition that could diminish your future earning capacity should be considered.

On the Internet, you will find many tools to help you make a more precise risk tolerance calculation. Mutual funds provide risk tolerance questionnaires such as the Vanguard Investor Questionnaire. Try several different surveys to get a broad perspective of your risk profile.

Smart investing is all about risk management – knowing the risks of an investment, and monitoring and managing them.

Learn more on the 6 Investment Risks Every Investor Should Know.