Risk tolerance

The risk tolerance article is intended to combine elements of the subject now mainly under “Risk and Return” (“Assessing Risk Tolerance”) and under “Asset Allocation” (“Need, ability, willingness”).

The goal is to make it easier for new investors to find risk tolerance and to find it mainly in one location. The page would begin with a new intro defining the basics of risk tolerance, in particular emotional risk tolerance, including what it is, why it's difficult to determine, and its key role in setting an asset allocation that stays the course.

Proposed outline:

Investing Start Up Kit

1 Are you ready to invest?

2. Understanding Risk, Introduction and explanation of terms used.

Financial Risk Tolerance

Emotional Risk Tolerance

Avoid common behavioral pitfalls.

3 Asset allocation

4 Create an investment plan

5 Create a well diversified, low cost portfolio

6 Maintain your portfolio

7 Notes

Asset allocation
From: Asset allocation:

Ability relates to an investor's ability to withstand the ups and downs of the market without getting nervous and making changes to the asset allocation. Selling in the face of a decline is about the worst thing an investor can do. Here is a table offered by author Larry Swedroe, based on the 1970s bear market, showing the amount of decline for various stock/bond allocations:


 * {| style="border-collapse: collapse;" border="1" cellpadding="3"

!Asset Allocation % (Stock/Bond) !Exposure to Maximum Loss For example, an investor would be willing to accept a loss of 35% in the portfolio if she held an allocation of (80% stocks / 20% bonds). This table is from the 1970's; performance during other time periods will have different results. The general idea is for investors to select an asset allocation they are comfortable with. Source: Investment Planning, forum discussion.
 * 20/80||5%
 * 30/70||10%
 * 40/60||15%
 * 50/50||20%
 * 60/40||25%
 * 70/30||30%
 * 80/20||35%
 * 90/10||40%
 * 100/0||50%
 * }
 * 70/30||30%
 * 80/20||35%
 * 90/10||40%
 * 100/0||50%
 * }
 * 90/10||40%
 * 100/0||50%
 * }
 * }