How To Assess Your ETF Risk Tolerance

After the market meltdown that led to the most recent recession, many financial analysts are re-assessing what risk tolerance is and how exchange traded fund (ETF) investors can deal with it.

Risk tolerance used to measure an investor’s tolerance of one aspect of risk: willingness to chance a big loss in pursuit of a big gain. Ben Levisohn for BusinessWeek reports that investors may fit neatly into boxes labeled aggressive, moderate or conservative. The problem is that such categories can lead them to ignore their responses to short-term risk-that is, volatility-and their fear of the unknown.

It is easier said than done when people say to take emotion out of investing, as everybody reacts differently to losses, gains and risk. Being aware of such states and reactions is important now, as the Dow Jones Industrial Average (^DJI) has hit 9,000 and the S&P 500 (^GSPC) has surpassed 1,000.

Daisy Maxey for The Wall Street Journal has three major points to consider when you think about your risk tolerance in any market:

• Age. To better address risk tolerance, a person’s age income, savings, retirement plans, state of health and stomach for volatility all come into account. Investors around 30-35 may welcome market declines for the buying opportunities, while someone in their 70-80s will fear it if they are invested in equities.
• Future. Investors with multiple goals may have multiple risk profiles. Net-worth is also a factor in asset allocation. For example, an investor with $1 million sitting in a bank account who plans to invest another $100,000 can likely afford some roll-of-the-dice investments, depending on his or her lifestyle. On the other hand, someone with a 401(k) valued at $200,000 may feel more conservative.
• Knowing Your Losses. Imagine how much you can lose and still keep a steady mind and hand if the worst were to happen. Basically, investors love risk when the market is on an upswing, but can’t handle it when it’s snowballing down. Know your personal limits.

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