What is Risk Tolerance?

EducationNovember 16, 2021

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In stock investing, risk is inevitable. Knowing how to determine your level of risk will help you manage your portfolio and make the right investment decisions that are right for you. And in this article, we will help you learn about risk tolerance (Risk Tolerance) in stock investment.

What is Risk Tolerance?

Risk Tolerance is a measure to assess the willingness to accept risk of investors. Determining risk tolerance will help investors quantify their investment decisions, instead of emotional decisions.

Depending on factors such as age, monthly income, stability of income, level of spending relative to income, volume of personal assets, time to achieve goals, knowledge… Investors have different risk tolerance.

Normally, risk tolerance is classified into 3 levels:

  • Aggressive Risk Tolerance
  • Moderate Risk Tolerance
  • Conservative Risk Tolerance

Usually, young people who are new to the financial markets tend to actively trade and have a high tolerance for risk. Meanwhile, older investors tend to reduce their risk tolerance to a lower level.

People with a large amount of investment capital but a high level of trading with high volume will have a lower risk tolerance than someone with the same amount of capital but lower investment requirements.

Or in terms of investment style, short-term investors have a lower level of risk than long-term investors.

Risk tolerance is often related to factors of investor psychology. This indicator is usually evaluated based on the proportion of risky assets that investors want in their portfolio.

For example, a person who wants to allocate 60% of his assets to stocks has a higher willingness to take risk than an investor who wants to hold only 10% of stocks and 90% of government bonds.

Capital management based on risk tolerance

1. High risk tolerance

Aggressive investors are usually those who have a good understanding of market trends and stock investments. This allows them to trade highly volatile instruments, such as small-cap companies or high-risk options. With these investors, profit and risk are both set to the maximum.

Simply put, investors with a high risk tolerance often put all their capital in the stock market, rather than allocating their portfolios to bonds or other assets to limit their investment. risk control. They generally prefer to invest in high growth regions of the world, such as emerging markets, BRIC countries or Asian countries excluding Japan.

Owning 100% of stocks in your portfolio also means high risk. That’s why, many traders choose to pour money into mutual funds with dozens, hundreds of different stocks.

2. Average risk tolerance

Medium risk traders often mix portfolio allocation and time balance. Specifically, instead of “putting all their eggs in one basket,” investors will combine different asset classes: stocks, mutual funds, and bonds. The investment period is usually medium-term, lasting from 5-10 years.

The average risk-loving investor typically pursues a 50/50 structure, with half of their portfolio being either growth or dividend-paying stocks or managed funds with large-cap stocks.

Large-cap stocks attract these investors because they are growth businesses with stable dividend payouts.

3. Low risk tolerance

Conservative investors with low risk tolerance often prioritize capital preservation over market returns, willing to accept little or no volatility in their portfolios.

Therefore, conservative investors often seek to protect the value of their portfolios by purchasing lower-risk securities such as fixed-income securities, short-term debt securities, blue-collar stocks. -chips or shares of large-cap companies or certificates of deposit (CDs) for income and capital preservation.

Compared to active investors or the average risk-loving investor, conservative investors earn much less returns. But with the advantage of safety, this style of trading is recommended for those nearing retirement age.

As an investor, you need to consider the profit & loss in the worst case by asset class to calculate your own risk tolerance. Thereby, you can orient your trading style and make more accurate and effective decisions.

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