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Asset Allocation - Measuring Your Risk Tolerance

Risk tolerance is a measure of your willingness to accept investment risk in exchange for higher potential returns. Risk is the uncertainty of earning your investment returns and is measured by the volatility of investment returns.

For example, if you're an aggressive investor, you're likely willing to accept the risk of losing some of your investment capital (that means a negative rate of return) in exchange for earning higher potential returns. Aggressive investors invest in growth stocks and growth funds, which are mutual funds that invest in growth stocks.

A conservative investor, on the other hand, is less willing to accept risk, even for higher potential returns. Capital preservation is a top priority for conservative investors. As a result, they tend to favor conservative investments such as certificates of deposit, money market accounts and government bonds.

Stocks have averaged yearly returns of about 12% over the last 50 years or so, according to data from publishers such as Center for Research in Security Prices at the University of Chicago. If an investor sought annual returns of 15%, they would have to invest in securities that have greater risk in hopes of achieving their desired return. They might consider investing in aggressive growth stocks or aggressive-stock funds.

To get an idea of your risk tolerance, take a few minutes to complete the following risk tolerance quiz.

1. I plan on using the money I am investing: Within 6 months. Within the next 3 years. Between 3 and 6 years. No sooner than 7 years from now.
2. My investments make up this share of assets (excluding home): More than 75%. 50% or more but less than 75%. 25% or more but less than 50%. Less than 25%.
3. I expect my future income to: Decrease. Remain the same or grow slowly. Grow faster than the rate of inflation. Grow quickly.
4. I have emergency savings: No. -- Yes, but less than I'd like to have. Yes.
5. I would risk this share in exchange for the same probability of doubling my money: Zero. 50%. 25%. 10%.
6. I have invested in stocks and stock mutual funds: No, and I don't wish to. Yes, but I was uneasy about it. No, but I look forward to it. Yes, and I was comfortable with it.
7. My most important investment goal is to: Preserve my original investment. Receive some growth and provide income. Grow faster than inflation but still provide some income. Grow as fast as possible. Income is not important today.

Source: Securities Industry Association

What is your cumulative number of points for all seven questions? If your total score is 30 or more points, this quiz suggests you are a very aggressive investor. If you score between 25 and 29 points, consider yourself an aggressive investor.

If you score between 20 and 24 points, you have a risk tolerance that is above average. If you score between 15 and 19 points, consider yourself a moderate investor. A moderate investor is one who is willing to accept some risk in exchange for a potential higher rate of return. Most investors likely fall in this category.

If you score fewer than 15 points, consider yourself a conservative investor. If you have fewer than 10 points, consider yourself a very conservative investor.

A risk tolerance quiz helps you to estimate your risk tolerance. You will find that risk tolerance quizzes abound so it's good to take a few different ones at financial Web sites to get a consistent profile of your risk tolerance. Finally, for specific investment advice, you should consult a financial adviser.

This information should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax adviser.

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