Understanding Your Risk Tolerance Level

What could go wrong when you pass your risk tolerance level? You can get into serious trouble by ignoring the risk limitations that you have set.

For example:

• You could make a bad decision and stick beside it, just making the problem worse.
• You could invest more than a stock is really worth.
• You buy a stock on a hot tip and don't really understand the investment.
• You are blinded by dollar signs, until they start dropping.

Whatever the reason you pass your risk tolerance level, it is usually based on emotion. In investing, emotions just don't work. It is all about the numbers. You can avoid risk problems by simply knowing what your level of risk tolerance is. This depends on your financial situation and your investment goals. Where are you at in life? There are some basic guidelines for investors and risk tolerance. For example, those nearing retirement need to be more conservative in their investments. Those just starting off in saving for retirement often have time to absorb some losses, and can afford risk in order to make large gains. But it really depends on your individual situation and how much risk you can handle.

In general, don't invest in anything you don't understand. Hot tips are never a good idea. You need to run the numbers behind every investment decision. They will tell you whether or not a stock may be a good deal. Don't invest money that you need for other things. Putting your house on the line in order to invest leaves you with way too much risk -- of becoming homeless, that is. If you buy a bad stock, take a small loss. Don't hold onto it hoping it will rebound. This usually just results in a larger loss. Admit the mistake and move on.

Going beyond your comfort zone can be a disaster. This is your money. Protect it the best you can. Often, you have to even protect it from yourself. Before you start any investment, understanding your risk tolerance level will help you avoid making emotional decisions that will often be disastrous.