|Course 501: Building a Portfolio, Part 1|
|Measuring Your Risk Tolerance|
So how do you measure risk and determine your risk tolerance? There are numerous formulas that will calculate a quantifiable risk number. You may also be concerned with a few more general risks. These include:
Losing money. The most basic risk is that you'll lose money when the price of the financial asset falls below the purchase price. When building a portfolio, look at losses in the context of the entire portfolio, not just at the loss that may occur in one investment.
Venturing into unfamiliar instruments. This is the fear of the unknown. You may be uncomfortable investing in a company or financial asset whose products and services you've never heard of or seen before.
Shunning familiar investments that you've lost money on. If you've previously lost money in an investment, you probably won't be inclined to reinvest money in that same investment. In this case, the psychological barrier usually outweighs the rational investment logic.
Going against the crowd. This is the fear of investing in companies that have been beaten down for whatever reason. Most individuals like investing with the crowd and feel that there is less risk when purchasing popular investments. In fact, the opposite may be true.
These are just a few of the ways to look at risk when attempting to gauge your individual risk tolerance. By carefully balancing your return objective with your risk tolerance, you will have designed a portfolio that fits your individual needs and financial circumstances.|
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