Risk Tolerance

What type of investor are you?

Hello 👋 and welcome to another issue of this newsletter. To the new subscribers, it’s nice to have you here.

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Today we look at investors based on their risk tolerance.

Before getting into it, yesterday I published an explainer on hedge funds based on Showtime’s series Billions. You can read about it here.

An explainer on Hedge Funds

Risk tolerance is the level of swings (especially negative) an investor can withstand. These swings/variances differ for different asset classes. Every investor needs to know how much risk they can stomach.

Risk or market risk include stock volatility, stock market swings, economic or political events, regulatory, or interest rate changes.  These factors can cause portfolios to slide.

When an investor overrates his/her risk tolerance, a large swing can make him/her panic and sell at the wrong time.

Depending on various reasons, including age, an investor can tolerate large or small risks.

 Higher risk is associated with a greater probability of higher return and lower risk with a greater probability of smaller return.

Investors that have high-risk tolerance are said to be aggressive investors.

Investors that have a low-risk tolerance are called conservative investors.

Investors that have a balanced risk tolerance are called moderate investors.

Each type of investor has a portfolio that matches their risk tolerance.

The general rule is that young people are aggressive and become more conservative as they grow older. Since young people have longer time horizons, they can rebuild after being wiped out, unlike older people looking to retire and avoid any serious market fluctuations.

A person's age, investment goals, income, and comfort level all determine their risk tolerance.

Aggressive investors have more percentage of their portfolios in equities, equity funds, ETF and more recently, cryptocurrency, while conservative investors have more in bonds, bond funds and fixed return assets.

Aggressiveness or conservatism of investors is a continuum.

 From aggressive investors➡️ moderately aggressive➡️ moderate investors➡️ moderately conservative➡️ conservative.

Profile of Conservative Investors

  • A lower risk tolerance

  • A shorter time horizon (typically considered less than three years, but could be shorter in the case of a goal like saving for a down payment)

  • A desire for steady returns that prioritize preserving capital

Profile of Aggressive Investors

  • A higher risk tolerance

  • A longer time horizon (more than three years, with the most aggressive accounts typically held for at least 10 years)

  • An appetite for higher returns

This wraps it up for this week. See you next Sunday.