The Stock Market: How Much Risk Can You Take?

By | October 10, 2012

NYSE trading floor

If you know anything about the stock market, you have probably heard that the higher the risk, the higher the reward. When it comes to taking that risk with your paycheck or life savings, however, you need to really think about the consequences of investing before you act. The question may not be how much risk should you take, but perhaps how much risk can you take?

  • As any good financial advisor will tell you, one of the biggest factors about investing in the stock market is usually how old you are and how close you are to retirement? According to CNNMoney.com, if you are 55 or younger, most financial advisors and online allocation-asset tools will recommend stock allocations of 70-percent or more if you are younger than 55. They also recommend you start to invest more conservatively as you get older closer to those golden years of retirement.
  • While this sounds like a reasonable plan, it won’t really help you in the long run if you stay up at night every time there is a market swing. Instead, asking yourself some tough questions about how you really feel about investing might give you a better peace of mind and save you from some sleepless nights.
  • What is your actual “pain tolerance” for investing in the stock market? Although your financial advisor might suggest putting 70-percent of your investment in the stock market and the remaining 30-percent somewhere else, you may discover that you are just not that comfortable investing that much of your portfolio into something that is often so volatile. If you do invest in the stock market, start with a small investment amount and see how you react to the market changes and how you really feel about it. If a couple of sudden losses don’t make you feel like the world is coming to an end, you may then wish to invest more heavily by doing it a little at a time until you discover what your actual pain threshold for the stock market really is.
  • Can you afford to lose the money right now? Although it is tempting to focus on how much money you might gain if you take the risk, ask yourself what the risk will be if you lose the money instead. If a big loss means you won’t be able to make your mortgage payment or you will wipe out your children’s college fund, you should consider another investment strategy instead.
  • How much money are you comfortable losing? If you put money into the stock market as a long term investment, you will see your stocks rise and fall many times over the passing years. If you break out in a cold sweat each time your investment in the stock market drops below 20 or 30-percent, you may find that even though you might actually make more money by remaining in the stock market, you might feel more comfortable by selling your shares and investing in bonds or a growth fund. This type of investment usually won’t make you as much money, but they might actually be the better choice for you when it comes to how you handle taking risks.

Jaclyn Young writes for several financial blogs. Check out tradingacademy.com for trading action.

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