You’re ready to start investing your money and rake in capital gains, but where should you plant your cash?
That depends on your level of risk tolerance, how much uncertainty your portfolio — and your emotions — can take when markets climb and fall.
Risk tolerance varies according to age, income level, financial goals and personality, so it pays to take a look at your situation before making the leap. Here are nine questions to get you thinking:
1. How old are you?
• Under 30
• 65 and over
This is the first question most financial planners will look at when determining risk tolerance. Here’s the thinking: The younger you are, the more risks you can take with your money because you still have ample time to turn things around before retirement.
2. How much money do you make?
• Under $25,000
• Between $25,000 and $50,000
• Between $51,000 and $100,000
• More than $100,000
The higher the income, the more risk tolerance the person has. After all, if someone worth $6 million loses half her income in the markets, she’s still sitting on a cool $3 million. But someone who lives paycheque to paycheque could wind up wiping out next month’s rent on a bad deal.
3. How would you feel if your investments went into a death-spiral?
• Completely on edge
• Like a failure
• Worried, but know I can handle the challenge
• Cool and calm.
Investments are supposed to hit rough patches. Now is a good time to buy low so I can sell high later. Not everyone is a glass-half-full type. It’s important to know what kind of personality you have so you can decide beforehand how you’re going to handle investment setbacks. Those who are uncomfortable with risk are more likely to sell before the markets recover.
4. What kind of mortgage do you have?
• Fixed. I like to know exactly what I’ll be paying each month.
• Variable. Emotionally, I can handle ups and downs because I’m saving money. I also have enough extra money in my account to deal with interest hikes when they happen.
There’s no shame in being risk-averse. But if you’re too afraid to take any risks and you actually have the means to do so, you’re missing out on great financial opportunities.
5. How much household debt do you have?
• So much I don’t even look at my credit card statements anymore
• A good portion of my income goes to paying off debt each month
• I pay my debts in full each month
• I am debt-free
The amount of debt should influence how much risk you take on when investing. In fact, out-of-control debt needs to be taken care of first before playing the stock market. Why? Even if your RRSP made 11 per cent interest last year, if you forked over 19 per cent for debt, you still actually lost money overall.
6. Who are you responsible for?
• Me, myself and I
• Older parents
• My spouse
• My spouse and children
• My children, no spouse
Of course you can gamble your money and still sleep at night if no one else will be affected but you. But once other dependents are in the picture, those risky moves may not be worth making.
7. When will you need the money?
• Within six months
• In one to five years
• In five to 10 years
• More than 10 years from now
Not all money is invested for retirement, but for other purchases. The longer time horizon you have, the more likely you can buy hot, but dicey, stocks instead of opting for a GIC or other low-risk investment.
8. What is the money needed for?
• A down-payment for a house
• My child’s education
• An emergency fund
• A convertible
In some ways, this is the most important question. Do you feel comfortable taking risks with your daughter’s university RESP money? Are you willing to spend a few more years saving for a down-payment if that hot stock you invested in to make money fast tanks? Know what you’re saving for before making your move.
9. How much investing experience do you have?
• I’m completely new to investing and trading
• I’ve been trading for a few years and understand mutual funds, but would like to branch into a new area
• I’m an experienced investor who keeps tabs on the markets each day
Get some education and experience under your belt before investing your money or trying something new. If you’re a complete newbie when it comes to investing, educate yourself by reading financial books, magazines and newspaper sections, watching personal finance TV shows or perusing money websites. Or find a financial adviser you trust to lead the way.
– Kira Vermond is Chatelaine’s money columnist and the author of Earn, Spend, Save (Wiley, 2010).