Having a good understanding of your own investment risk tolerance is very crucial for any successful investing career. For those who are using the services of an investment advisor, things like age, size of investment portfolio, expected retirement date, future earnings, and financial obligations are usually explored to measure risk tolerance.
The first step in personality determination is to understand the investor’s personal background. Knowing his or her life experience, inherited traits, career paths, as well as their present investment portfolio can let him or her know about their willingness to take risks. He or she will also know if he or she would be prone to making decisions solely based on his or her emotions.
There are investment firms that have developed client questionnaires to help them with the standardization of the steps. After understanding your background, you can generally place yourself in one of the following personality types.
Lower Risk Tolerance
Investors who are cautious make decisions primarily on feelings. They are usually very sensitive to losses. Fear is the primary driver of their investment decisions.
That also means they often have problems coming up with proactive decisions over their investments and they don’t trust the advice of others. Because of this, their portfolios usually have low turnover and include mostly safe investments.
Methodical investors follow a disciplined and mechanical trading strategy. They come up with investment decisions based on hard facts and they will often nitpick about small details.
These kinds of investors heavily depend on investment research and they are not too emotional about their decisions in investments. Overall, they tend to be disciplined investors that have lower risk tolerance.
Higher Risk Tolerance
Investors who are spontaneous come up with investment decisions based on feelings and act upon them frequently. These investors usually second guess themselves as well as the advice of other people. They also almost always go after investment fads.
And because of all of these, their investment portfolios usually exhibit high portfolio turnover, usually also including riskier investments.
Individualists are those that make decisions based on hard facts. These investors usually do not second guess their decisions. They also practice independent thinking and pour a huge amount of trust in their investment research.
And because of these, they are usually less risk averse than other types of investors. Individualist investors are typically self-made ones and hard workers.
Total Risks Tolerance
One investor’s personality type and willingness to take on risk can be used along with his or her ability to take on risk to better judge his or her overall risk tolerance.
There are times when an investor’s willingness to take on risk will be much different from his or her actual ability to take such risks. When this happens, deeper and better education of the capital markets and investment risk may be required to resolve the problems.
Building a truly personalized investment portfolio involves a good understanding of both the willingness and ability to take risk.