Risk tolerance sounds a little complex, though it is something that affects anyone who spends money on a speculative venture. This could be from the small boy who invests in collectors cards right through to the stock market speculator, and what it means is evaluating whether you can afford the investment or any consequential losses entailed in that investment.
If the small boy spends everything he has in the hope that his collection will pay off, he risks loss, just as the large investor that speculates on the stock market, and if that boy borrows to buy those cards, his risk tolerance is reduced because others depend upon their money being returned.
There are many different areas within the personal finance spectrum where risk is involved, and these include the following though this is by no means exhaustive;
*Housing
*Investment plans
*Insurances
*Stock market investments
*Vehicle purchases
*Leisure
It can be seen from the list above that there really is a whole lot of risk involved in the spending practices of human beings, and each of them carry a risk factor. Let’s examine those risk factors in order to help the reader establish their element of risk tolerance.
Housing
Housing is a common investment and the tolerance lies in the preparation that takes place before putting money into housing that will make a loss. Here, it is important to assess the price of the home, the price of fees and also the price of renovation works in order to make the investment valuable. Without planning, mistakes happen, and the risk tolerance means make or break. For example if you were to purchase a home at 100,000 dollars and the renovation works came to an estimated 20,000, the value of the home must exceed those figures to break even.
The risk tolerance is the common sense figure that you can afford and in this case if your budget was 110,000 dollars, your risk tolerance would be 10,000 dollars, giving you a buffer to use if the property turns out to be more expensive than you thought to renovate. When buying a home for investment, the risk tolerance needs to be high enough to take account of repairs. Buying a home with a zero tolerance, i.e. A budget of 100,000 it would not be possible to repair the home, and the risk of failure increases because you cannot make the investment more valuable than when you bought it, because your funds do not allow it.
Investment Plans.
The element of risk in an investment plan depends upon how speculative it is. Many depend upon the stock market and do warn you that there is a risk element if the stock market falls. These can be high return investments, though if you are poor, a safer bet would be to have a long term investment plan with a guaranteed return, because it protects the money you put in and reduces your risk. The tolerance of risk in an investment plan situation is how much you are prepared to lose if the worst case scenario happens.
Insurances
With insurances, there is always a slight risk, though by taking out prudent insurances that will pay at the end in a lump sum, or that protect your loved ones, that money you pay in isn’t risked. It’s fairly safe if you invest it in a monthly payment plan that is easily affordable. Often people up their risk factor by taking out insurance that they really cannot afford, and in the end have to stop paying through financial restraint, and consequently lose money. The only risk with taking out insurances of this nature is gambling upon being able to afford the payments throughout even those months when money is short. By taking out modest insurances that are easily affordable, you reduce the risk factor.
Stock market investments.
These are for people that know what they are doing. If you have very little money and want a good return do speak to experts. If indeed you are not wealthy, the risk tolerance that you have is lessened. Richer people can be more speculative and take risks, though for the man on the street with low income, the risk tolerance is not really acceptable to throw money into investments of this nature not knowing the market trends, and risking loss of everything they invest through ignorance.
Vehicle purchase.
Do you know how much money you risk when you buy a brand new car ? The minute a car is put onto the road, the value of the car diminishes. When buying a vehicle when you have very little money the risk is high with new vehicles since you will never get the same money back for the car you buy. If reliability is what you are looking for, cheaper alternatives lower the risk factor, and can offer the reliability you seek, being one or two years old with a guarantee from a reputable garage.
Leisure.
Risk plays a lot in leisure activities. Can you afford to spend on expensive leisure equipment ? Can you afford to gamble ? Every year people gamble their money on lottery tickets and in casinos and on-line betting sites and many cannot recognize their own risk tolerance. They get hooked. They bet and lose, and bet again in an attempt to gain back the money they lost. This is speculation at it’s very worst, but speculation that affects millions of people worldwide.
When betting, if you cannot afford to lose the ten dollars you place on a bet, your risk tolerance is zero. You would be wiser to walk away from betting if this is the case. A man who is a millionaire doesn’t think twice about betting 10 dollars and his risk tolerance is much higher.
Tolerance is a simple measurement of what you can afford to lose whether it be in speculative investment, real estate purchase, vehicle purchase or betting. If you cannot afford to lose that money, then the best way forward is to put the money into something where there is no element of risk.