There is no doubt in my mind that most people wouldn’t mind being rich. There’s also no doubt in my mind that a number of people would be attracted to “High Returns” investment vehicles. However, they often forget about one key point on determining which investment products would be suitable for them. That key point is, risk tolerance level.
I’ve always believed that one must determine their risk tolerance level first before embarking on his/her wealth-creation journey. Understanding risk as a whole and understanding how much risk you are willing to take is really important. You don’t really have to take a university course on this, learning about utility theory, portfolio theory, and etc. (though it would be beneficial), but you need to understand how you would react to the increasing risk of investments.
Often I see that a number of people invest their money in a high-returns investment products without knowing that high returns usually goes together with high risk. All they see is the product’s track record and get hyped up with its ability to produce really high returns. The next thing they know, the product records negative return. Then they panicked, sold everything, and get frustrated. Take HYIP (High Yield Investment Programme) like Swisscash for example. Yes, you can expect returns of something like 4% per day, but 90% of HYIP participants can’t even make their money back! As you all know, I am againts any HYIP. Might want to have a look at my post on these programmes.
Alright, back to the discussion of risk tolerance level.
Let’s take Public Islamic Opportunities Fund for example. Recently, they recorded a return of around 47.42% in a year. Yup, 47.42% in a single year. Though this is great, one must understand that the fund could easily record a negative return as well. After all, it is an aggressive fund catered for aggressive investors.
To determine one’s risk tolerance level, one must ask himself a number of questions such as:
1. How will I react if the fund suddenly goes down by, let’s say, 20%?
2. How long do I plan to have that money invested? In other words, do I need the money in the near future?
3. Will I be able to sleep at night knowing that the fund has declined in value and keeps on declining?
4. Do I understand the concept of higher returns equal higher risk?
5. How much of financial knowledge do I possess?
Below are three websites that provide tests to determine your risk tolerance level. As determining risk tolerance level is a subjective issue, these tests might no be so accurate. Well, at least it is an indicator. Also, there are a number of tests out there that might be of some use.
However, you need to understand that at the end of the day, you determine how much risk you are comfortable with.