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Risk is a crazy thing. Take on too much and you either crash and burn or you make out like a bandit. Take on too little and you either just float along or you make out like a bandit. The “trick” is figuring out how that happy medium that you will be comfortable with. I have spent some time determining what my risk profile is.
For a definition of the most common risk profiles, see this post here. There are a lot of tools on the web to help determine risk profiles, but the one that I like the best is at the TIAA-CREF website. It is quick to do and the results work.
Click to EnlargeMy results from the tool are presented above – I am classified as an Aggressive, which means:
You can tolerate volatility and significant fluctuations in the value of your investment because you realize that historically, equities perform better than other types of investments. You’re looking for long-term capital growth and are less concerned with shorter term volatility.
This profile does not mean that I will not hold any fixed income assets in my portfolio – only that my focus and the majority of my portfolio will be focused on equities.
My risk profile is going to set the framework for decisions down the road, especially in terms of asset allocation. With this profile, I know that I can withstand a good deal of risk with the expectations that I will receive higher returns. Put another way, I will be comfortable having a higher percentage of my portfolio in equities as opposed to fixed income assets. This feeds directly into my chosen asset allocation, which I am going to talk about in Part 3 – My Asset Allocation.
Understanding what your risk profile is BEFORE buying into investments is extremely important for individual investors. There are a lot of investors who end up selling out of equities at their lows because they can’t take the ups and downs of the market, when they should have understood that going in.
Would it be dumb to say I am more defensive with individual stocks and agressive with mutual funds? I am curious about how this translate into risk because mutual funds are a broad exposure versus individual stocks which are specific.
How do I know when a stock is selling at a discount?
@Mike,
you can use the P/E ratio or look at a stock that drops because of the overall market and not because there are specific bad news about this company.
For example, Intel dropped along with the market this year but the company is doing just fine. I recently bought some as I thought it was selling at discount.
You can also look at a stock that pays a higher dividend than usual. If there is no reason related to the company, you may have found a discounted stock.