Managing risk is an essential and unavoidable component of most actions you can take with your money. Risk is not inherently “good” or “bad” and that can lead to some confusion around how to manage it effectively, particularly when doing nothing can be risky for your finances too.
If you are looking to make some important decisions regarding your money and how you spend, save and invest it, understanding financial risk should play a key role in your next steps. In this guide, we will walk you through everything you should know about financial risk, as well as answer the big question: “How much risk should I really take?”
The amount of financial risk you take comes down to not only your own personal risk tolerance, but also your current financial circumstances. When you are assessing your risk level, ask yourself questions like:
It makes sense that someone with savings and steady work can usually take more risk with, say, higher-risk investments than someone living month-to-month. Nobody likes a loss, but if you have a good financial cushion, you will at least be able to bounce back better.
Let’s say you are planning to invest your money to achieve a short-term or long-term goal, like saving for an early retirement or paying off debt. The goal you have in mind and how quickly you want to achieve it will influence the level of risk you will take.
Many people do not realise that time also affects financial risk. If you have ever looked at a performance chart for virtually any stock or asset, you will likely have noticed big dips and random peaks. This is normal, as markets have good years and bad years.
But over time, any ups and downs in investing typically get smoothed out. In an ideal world, you should see an upward-trending line over the years, as the ups and downs average out over time. So, generally speaking, the longer your investment can sit untouched, the better.
Ultimately, the level of financial or investment risk you should take comes down to your own personal comfort levels.
Maybe you only feel comfortable taking on low-risk investments, like high-yield savings accounts and government bonds, as the idea of potentially losing money is simply too scary. Or maybe you have swung completely the other way and will not be losing any sleep even during volatile market periods.
If you are brand new to your investment strategy, you will probably want to start relatively low-risk and take on riskier assets over time, depending on your financial position and goals.
If you want to meet your investment goals, you may be required to make riskier moves financially, but you should always keep your financial situation and risk tolerance in mind.
There are ways to go about balancing risk, too, such as building an emergency fund that serves as a financial cushion and makes you feel more comfortable with riskier investment decisions. It is also important to diversify your money across different assets. Diversification reduces your chances of a big loss if financial markets do not perform as you hope.
Most importantly, always do your own research and seek help from a professional financial advisor if you think you would benefit from external guidance.
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