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Avoiding Debt By Determining Risk Tolerance

Have some extra cash on your personal balance sheet? Don't worry, there will be somewhere to put it. No matter where you look these days, there's an "investment opportunity" ready for you to drop money on. With the increased use of the Internet, the number of opportunities has of course increased! But when deciding on an asset class in which to invest in, you should know your risk tolerance. Because of the fact that investing is basically a risk-reward correlated activity, it is important to know your ability to tolerate risk, or find yourself with problems in the future. Your risk tolerance may vary depending on the end-goal of the investment - it may be for retirement, education, or speculation, for example - and it is important that you understand your own ability to cope with a gain, but more importantly, a loss, should that time come.


Self-Assessment - Not Easy, But You Must Do It

When attempting to assess your personal risk tolerance, a single question could be the most important to ask: "Am I willing to take a loss in order to potentially profit?" If the answer is no, you're at least half of the way to determining that you have a very low risk tolerance. In cases like this, most professional financial advisors would probably recommend real return bonds or certificates of deposit as your main investment choice. Certainly purchasing individual stocks may be all but out of the question.


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Next up, if you are in fact willing to accept a loss, how long can you accept this loss for? One of the better performing investing philosophy involves "buying and holding", so this is a key concept. If you feel you could only deal with a loss for a short period, your risk tolerance is lower than if you feel you could withstand it. Understanding your ability to deal with risk is critical to know even before you begin investing. It could save you lots of pain and strife in the future.


So Your Investment Goals Are Big, Your Risk Tolerance, Not So Much

Hey, no-one's perfect. We all want to have our cake and eat it too, right? But if you have big hopes, but low tolerance risks, something is going to have to change. As an example, consider taking your investment goals down a notch. The fact is, something's got to give, and if your risk tolerance isn't likely going to change, your goals must. Adjusting your goals to include a longer time span is a great way to get the best of both worlds, as the more time you require to reach your investment goal, the less risk you're probably dealing with.


Inflation is a key factor that everyone should consider (read about Inflation and its effects on Retirement here) when investing. The sad fact about inflation is that it is always there, and if your investment goals are too conservative, you could actually lose in the long term. If this is the case, you may want to bring your investment goals up a notch, as without any risk, you're liable to have zero reward.


Addressing your risk tolerance early on is a superb way to begin to foray into the world of investing. Understanding it can mean the difference between a superb retirement, and a load of debt.

 


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