4 of the Best Questions to Ask to Determine Your Investment Risk Tolerance 

As you begin to choose between different asset classes for investment, or even different assets within the same class, you need to consider your tolerance for risk. The risk profiles of even closely related securities, such as stocks that pay dividends and those that do not, can vary considerably.

Understanding your risk tolerance makes it easier to choose appropriate investments and expand your portfolio in a way that supports your personal goals and comfort level. However, identifying your risk tolerance is easier said than done. The term risk tolerance refers to the amount of risk you are willing to accept with your investments. Risk simultaneously means potential for growth and the possibility of losing big.

A significant part of risk tolerance that sometimes gets overlooked has to do with market swings and uncertainty about the future. If you tend to be a reactive investor who gets nervous when the market experiences a swing, high levels of risk may not be best for you as low levels of risk will help you feel more secure in your position. For many investors, loss aversion plays a bigger role in risk tolerance than the potential for gains. Remember that risk tolerance changes over time and needs to be revisited frequently.

You can ask yourself questions to tease out your personal risk tolerance. Here are four of the most informative questions to ask:

1. What is your investment horizon?

An important factor to consider in relation to risk tolerance is time. This is also a factor that will change, so it may affect how you approach risk. As a general rule, the longer it will be before you need to withdraw your money, the more risk you can accept because you have time to recover from losses.

Historically, the stock market has returned about 7 percent annually after accounting for inflation provided that you can wait out the downturns. With a shorter investment horizon, this is not always the case, and you could find yourself locked into significant losses.

For this reason, people tend to get more conservative as the amount of time before they will need the money grows closer. Assuming less risk reduces the chances that you have a sudden decrease in the value of your portfolio. As the time horizon changes, so too will your risk tolerance.

2. What is your investment goal?

What your goals are also affects your risk tolerance. Young people saving for retirement tend to accept greater risk because of the long amount of time before the money will be needed. However, if you intend to buy a house or to fund a child’s education, then you have a much shorter time horizon and may have a lower risk tolerance.

Goals can also have an influence on risk tolerance outside of the time horizon. For example, imagine that you hope to leave your grandchildren an inheritance. Your risk tolerance for a goal like this will be different than it would if you are saving for your own retirement.

Defining goals will help you create a pathway to follow to achieve them, which will force you to think more critically about risk. Remember that you can have multiple goals at the same time and need to prioritize them appropriately.

3. What kind of financial cushion do you have?

Another consideration is how robust your liquid savings are. Ideally, you already have an emergency fund that you can access in the event of a job loss or accident. However, this is not always the case or perhaps the fund is not quite as large as you would like. In this case, you may need to liquidate investments in the event of an emergency.

This may make you less tolerant of risk since you may end up relying on your investment accounts in the short term. If the investment accounts take a big loss, you could be in a difficult financial place should an emergency occur. On the other hand, if you have a healthy emergency fund, then you may be more accepting of investment risk since you will unlikely need the invested money in the short term.

4. How much do your emotions drive you?

Understanding your relationship to emotions is important in calculating risk tolerance. If you know that your emotions often drive your decision-making, then you may benefit from a portfolio with lower overall risk that minimize losses. Investors driven by emotion sometimes react by selling during down markets, locking in losses rather than waiting for prices to rebound.

However, if you can control your emotions and approach situations objectively, then you are more likely to wait out the market downturns and again see the value of your portfolio restored. Be honest with yourself and your emotions and protect yourself from doing things that will cost you money down the line. Your relationship with your emotions may also change over time as you learn more and get comfortable with investing.

You Should Be Familiar with These 6 Types of Alternative Investments

As you get more immersed in the investing world, you will likely hear the somewhat confusing term “alternative investments.” The problem with this term is that it is a large category that covers many different types of investments. In short, alternative investments are those asset classes other than stocks, bonds, or cash. Typically, these investments are not very liquid, which increases the risk involved with investing in them. A large number of asset classes fall under the umbrella of alternative investments and they can look and act very different from each other. You should take some time to learn about these different assets since they are becoming increasingly available to individual investors and could play an important role in your portfolio, especially since they tend to have a low correlation with the movement of standard asset classes. Some of the key alternative investments to know include:

Commodities

The category of commodities includes real assets, most of which are natural resources like gas, oil, agricultural products, or precious metals like gold. Notably, commodities are among the oldest forms of investment with exchanges dating back thousands of years. People tend to invest in commodities as a hedge against inflation since their value rises in line with supply and demand. Value tends to increase during periods of high inflation as supply decreases and demand increases. However, this sort of price movement is not guaranteed, so you need to be cautious when you invest in commodities and do some research on historic performance.

Real estate

The largest asset class in the world is real estate. This unique class has features similar to both equities and bonds. As with equities, the goal is to increase the value of the asset over time, a process called capital appreciation. Like with bonds, you can charge rent and receive cash flow from the asset. One of the biggest challenges in real estate remains valuation and the investors who perform the best in this category understand when to apply various valuation strategies based on circumstances. Doing this helps them identify the best deals to help them meet their goals. Many valuation strategies exist, including comparables, income capitalization, and discounted cash flow. Each of these has its own benefits and limitations.

Private equity

Another broad category of alternative investment is private equity. This category includes any capital investment in a private company not listed on a public exchange. Venture capital, growth capital, and buyouts all fall within this category. These represent different types of investments at various stages of growth for the company. Typically, private equity investments are made by specialty firms that can provide much more than capital. These firms often help find talent, provide mentorship to leadership, and give important advice on growth moves.

Structured products

The category of structured products typically involves fixed income markets and investments that pay dividends. Some popular structured products include credit default swaps and collateralized debt obligations. These products tend to be very complex and can involve considerable risk. However, these products are also very customizable, which makes them ideal for people with particular needs. However, you would need to find someone to issue that particular product. Investment banks will often make these products for hedge funds, retail investors, and other organizations.

Private debt

The term private debt refers to investments that are not financed by banks or traded in the market. Both public and private companies can use private debt when they need more money to help the business grow. Companies that issue this capital are referred to as private debt funds and they make money through interest payments on the money and the repayment of the loan. Essentially, private debt is like making a bank loan as an investor with a mutually agreed upon interest rate. This investment comes with significant risk since there is always the chance that companies will default on the loan. While private debt does not get traded on exchanges, these loans can be bought and sold between investors, which may happen if they become distressed.


CollectiblesMany different items get collected, including cars, wines, toys, art, stamps, and coins. When you invest in collectibles, you purchase the actual asset and hold onto it with the hope that it appreciates in value over time. For many people, investing in collectibles is fun, especially if they have some interest in the particular item. However, this strategy comes with a lot of risk since you often need to pay a considerable amount of money upfront and receive no dividends. The asset could be destroyed or decrease in value so that you actually lose out on money once you sell it. To really make money through collectibles, you need to be an expert on the particular asset you are purchasing.

This Is How to Evaluate Country Risk When Investing Internationally

As you grow your investment portfolio, you may start looking into diversification with unique investments like junk bonds or dividend stocks. One of the best ways to diversify a portfolio is international investing. However, choosing to purchase stocks or bonds from different countries comes with varying risks, so it is important to account for this as you make investment decisions.  

One concept you should know is country risk, which refers to the economic and political conditions of a certain jurisdiction and how they may affect business that takes place there. Of course, these risks evolve over time, so the risk 10 years ago for a country likely does not look like the risk that exists today. Thus, country risk is something that needs to be monitored and managed over time. Of course, you need to understand how to measure country risk in the first place. 

Quantifying Country Risk for International Investments 

The process of measuring risk for a specific country can be extremely tricky. In general, investors need to take hundreds of different points into account, from political movements to tax laws. These points may change at any given moment as new groups take power or interest rates change. A simple change can have a dramatic effect on a country’s stock market and business landscape. At the same time, something as small as a statement from a political official can have a major impact. To begin breaking down this complicated task, most people divide country risk into economic and political risk. Economic risk refers to a country’s ability to repay its debts and its overall financial stability. Political risk involves the politicians that lead a country and the impact their decisions may have on investment.  

An example of economic risk is a country’s existing debt. If the debt a country carries is much higher than its gross domestic product, then the country may struggle to raise money to support itself. This means that the country may be less likely to repay debts.  

Political risk would include new leaders who want to grow certain industries, perhaps to the detriment of other industries within the nation. Often, economic and political risks become intertwined. Politicians may implement policies that undermine the economy, such as spending money from foreign reserves. Thus, the distinction is not always the most helpful. 

Analyzing the Risk Involved with Foreign Investing 

Beyond quantifying the risk of investing internationally, you need to be able to analyze it. Investors use several different tools to complete this analysis, including beta coefficients and sovereign ratings. In reality, people should use a combination of different tools to analyze country risk and how it impacts the risk involved with a particular investment or security.  

There are both quantitative and qualitative approaches to risk analysis. For the most part, quantitative analyses use ratios or statistics. You can find the hard data you need to complete these analyses through various rating agencies, financial information providers, or publications. Qualitative analysis uses more subjective information like news articles or opinion pieces in reputable sources like The Wall Street Journal

Perhaps the most common strategy for assessing country risk is the use of sovereign ratings. Agencies consider both quantitative and qualitative data to create credit ratings for each country. These ratings are useful because they allow for direct comparison between countries, which can be particularly helpful when you are deciding between investment options. There are many ratings agencies, but the most popular are Standard & Poor’s, Fitch Ratings, and Moody’s Investor Services. 

Investigating Country Risk as an Individual Investor 

Beginner investors can quickly become overwhelmed by the amount of information available to them when it comes to determining country risk. A great place to start is with sovereign ratings through one of the previously mentioned agencies. This information provides you with a baseline for the level of risk. Once you have established this baseline, be sure to watch for any negative updates in the news that might affect the ratings.  

Search Google News or an international news aggregator on the country in question to get some more qualitative data. In addition, you could look at some public data sources like the World Bank or the International Monetary Fund. You will also need to do some quantitative work to get a full picture of risk. A beta coefficient is usually sufficient. A higher beta coefficient for a country implies greater risk. 

Importantly, a nation with high country risk is not necessarily problematic. For example, countries undergoing significant economic reform tend to be very risky during that period but may have a bright long-term future. As you decide on international investments, you should additionally consider how the particular asset would add to diversification. Also, remember that you need to keep a very close eye on international investments because situations can change rapidly in these markets, which is especially true with the riskier ones. When you start to see indications that problems are on the horizon, then it is time to decide if you want to ride out the storm or try to sell.  

Keep These 5 Critical Points in Mind When Considering an IPO Investment 

Institutional investors often include risky investments like distressed debt and initial public offerings (IPOs) in their portfolios. High-risk investments such as these come with the possibility of large returns. At the same time, investors should keep in mind that they could lose these investments completely, which is why the riskiest assets are typically reserved for institutional investors with very large portfolios.  

As with any investment, IPOs are never guaranteed. Even successful companies, like Blue Apron, have had IPOs completely fail. While IPOs can earn you a lot of money, it is best to be cautious before you invest. The following are some key points to consider before participating in an IPO: 

  1. A strong broker is a good sign.  

As you consider a company about to undergo an IPO, pay close attention to the underwriters of these transactions. Companies that work with any of the larger investment banks are generally safer bets. While these large investment banks have certainly helped launch failures in the past, quality brokerages signal a certain level of trust in the company’s success. Smaller brokerages may underwrite any company, so their backing does not mean nearly as much as a company that is underwritten by Goldman Sachs, for example.  

Note that large brokerage firms typically will not allow you to participate in an IPO as your first investment. IPOs are generally only available to established investors with high net worth. However, this is not always true with smaller boutique brokers, so that could be a way in if you do not have an established history. 

2. Objective data is hard to find.  

You will want to get as much objective data on companies about to go public as possible. However, private companies typically do not have a lot of analysts combing through their finances, so this information can be difficult to find. The prospectus will have a lot of financial information about the company, but this document is ultimately written by the company itself and thus not an unbiased source of information.  

Turn to the Internet to see if you can find any more objective data about the company and its competitors. You should also do some research about the target company’s industry. Even if objective information is nearly impossible to find, every little bit provides critical insight and will help you make the best investment decision. You may be surprised by how quickly you find out that a company’s prospects have been exaggerated. 

3. The end of the lock-up period is telling.  

The underwriters of the IPO and company insiders enter a legally binding contract called the lock-up period, which prevents trade for a period of three to 24 months. Investors often wait until the end of the lock-up period to act on their IPO stock. If you notice that none of the insiders sell their stock when the period ends, you should take this as a sign of stability for the investment and the company itself.  

Unfortunately, there is no way to tell if insiders would rather sell during the lock-up period since they are legally prohibited from doing so. Waiting for the period to end is a good strategy since, in the end, a worthy investment will remain so after this timeframe expires. 

4. The prospectus is a necessary read.  

The prospectus for a company needs to be read with a critical eye since it is written from a biased standpoint. However, this does not mean that you should ignore the prospectus altogether. While the document itself is dry reading, it will help you frame the risks and opportunities presented by the IPO as well as understand what the company plans to do with the money raised by the IPO.  

As a general rule, using IPO money to repay loans or buy equity from private investors is a bad sign since it indicates that the company cannot pay debts without issuing stock. However, if the money is going toward research, marketing, or company expansion, that indicates a healthier place for the company and the potential for increased profits in the future. Also, pay close attention to the earnings outlook. If a company overpromises, that is a bad sign. 

5. Be skeptical before investing.  

Because IPOs generally do not provide much reliable information, you should always approach an IPO with a generous amount of caution, especially if it is being pitched to you by a broker. While brokers may try to push an IPO as a great deal, always ask questions. For instance, why is there an excess of stock if the deal is so great?  

Also, it is important to keep in mind that individual investors only rarely get access to shares of an IPO for a highly respected company. Brokers tend to save these stocks for their star clients, making it difficult for anyone else to access them. Even if you do get access to an IPO from a respectable company, remember that this still comes with many risks that the average stock does not have.