By Rick Kahler via Iris.xyz
Last week I discussed the importance of understanding how much risk you can comfortably tolerate in your investments. If you are new to investing, or if you aren’t sure how much risk you are taking in your current portfolio, it may be helpful to spend a little time to determine your risk tolerance.
A good place to start is by taking a few risk tolerance surveys. A variety of free assessments are available online; three examples are at Vanguard, Schwab, and Morningstar.
I like surveys that express your risk in terms of downside volatility, or how much loss you could tolerate. Most will express the downside in terms of how far your portfolio would have to go down over a 12-month period before you would jump out.
Unless you only look at your portfolio once a year (which I highly recommend), you most likely won’t tend to think of a decline in your investments as being over a 12-month period. Because we all “anchor” on the highest value, it’s more typical to compare a portfolio’s peak value to its lowest point. You may want to ask yourself how far would the markets need to drop from their highs before you would want to get out “before it’s all gone.” It’s important to understand that the peak to trough drop will usually be much higher than the annual drop. For example, in 2008-2009 the peak to bottom drop in some portfolios was 40% when the 12-month drop was closer to 20%.
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