Why it’s important for you.
Yet another extravagant term that gets tossed around in the financial world is “risk tolerance”. Fancy words don’t impress us much and we prefer to use more relatable language here at Firreo. Let’s dig into what the pretentious Wall Street types mean when they say “investor risk tolerance” is such and such.
Risk tolerance is how much risk you are willing to take when you’re deciding whether to invest in something or not. Not how much someone else tells you to take, but how much risk you are okay with. Think of it like a spectrum, where one end is unwilling to accept any risk at all and the other end is willing to get super risky. This is important in investing because, depending on your personal risk tolerance, you will want to choose certain types of investments over others.
As a result, your risk tolerance tells you the type of investments you should invest in. Which also will give you an idea of the return you might get (i.e. how much you make on the investment). Generally, the more risk you take, the higher the return. If you’re not okay with losing a penny on an investment, you’d probably keep your money in the bank and you won’t make much on that money because you’re not taking any risk. If you love being super risky, perhaps stock options or crypto are for you.
Here’s a few terms that are commonly used to describe an investor’s risk tolerance.
Conservative (low returns, high safety) – This type of investor prioritizes hanging on to every invested dollar over all else. They’re happy to sacrifice larger returns on riskier investments in order to avoid the chance that their initial investment loses value. Conservative investors are usually those who have all the money they need and simply want to preserve what they’ve got. Tt can also include those who totally can’t handle the psychological effect of losing a single penny.
- Examples of conservative investments include savings accounts, CDs, U.S. savings bonds, and other U.S. government-guaranteed investments. In extreme cases, it means this type of investor keeps actual cash under their mattress.
Aggressive (high returns, low safety) – These investors are bold and like to take risks. They are looking to invest in relatively risky investments over a long-term horizon (5+ years) to smooth out short-term market mayhem and dropping investment values. After all the booms and busts average out, investments in this category have historically returned 8% or more per year. Aggressive investors have to be mentally prepared to watch their hard-earned investments take a beating, sometimes for years at a time, in order to realize the long-term gain.
- Examples of aggressive investments include individual stocks and individual ETFs, some types of real estate, and some “alternative” investments. Crypto is an example of an extremely high-risk investment that is only suitable for the most aggressive investors.
Moderate (medium returns, medium safety) – No surprise, investors with a moderate risk tolerance land in between conservative and aggressive. These investors are willing to take some risk to get a higher return, but they either want to have measurable amount that their investment could lose or they want their investment back pretty quickly (3 years or less).
- Examples of moderate risk investments include short- to intermediate-term bonds, municipal bonds, and some stocks like “consumer staples” (things people always need like food, toiletries, stuff for your house, and yes… even alcohol).
So what risk tolerance do Firreo users have? Glad you asked! Our users are typically moderate to aggressive risk tolerance. They understand that to get the high returns necessary to achieve financial independence, they’ve got to take a bit of risk to grow their money and create predictable investment income. We start our new users with investment recommendations in a pretty aggressive stance and then slowly taper the risk down over time. A bit of a goldilocks approach👌.
All risk tolerances have their place in an investor’s journey, and your risk tolerance may very well change over the years. But in the meantime, try out Firreo and see where your journey might lead!
For lots more on how to crush the personal finance game and find early retirement, make Firreo your financial advisor. We’ll help you out of your job and on your way to financial freedom!