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The decision to save for retirement is an easy one when you consider the potential future benefits, but how to invest is often the source of uncertainty and frustration for new investors.
Before investing, it’s important to know what kind of investor you are so you can select a mix of investments consistent with your financial situation and your risk tolerance. Assessing your risk tolerance is a key factor in determining what kind of investor you are.
What is risk?
Risk can be defined as the possibility of losing all or part of your investment. The potential for higher returns goes hand-in-hand with higher risk. Conversely, low-risk investments are associated with lower returns. Before you consider any investment, it is important to understand risk and to determine your risk tolerance. This tool will help you to determine your risk tolerance.
Select the response to each statement that most closely matches your own investment philosophy. After completing this exercise, you'll have a chance to craft the appropriate mix of investments to fit your risk profile.
1. Previous Investing Experience
I've been investing in stocks or bonds, either as mutual funds or as individual securities, for:
2. Investment Preferences
Overall, I prefer the following investment types:
3. Risk Aversion
If a stock or bond investment of mine dropped significantly in value, I would move my money out of it.
4. Risk Tolerance
Assume you're investing $5,000 of your own money and have the following four investments from which to choose. Based on the range of possible ending values for these investments, which one would you pick?
5. Growth or Income
Of the following statements, select the one that most closely reflects your risk tolerance and approach to reaching your retirement goals:
6. Time Horizon
The number of years that you invest is one of the most important factors in picking an asset allocation. The more time that you have to invest, the more you can afford to have higher-return, higher-risk investments like stocks and bonds in your portfolio.
How many years until you plan to begin drawing funds from your portfolio?
A more conservative investment strategy may be appropriate when many people are dependent on your future income.
How many dependents, including children and elderly parents, will you be supporting during your retirement years?
8. Current Net Worth
Your asset allocation also depends upon the total value of your assets, your "net worth." Be sure to include your primary residence and all savings investments.
What is the total of your assets?
9. Retirement Savings
The size of your retirement nest egg is another factor that affects your allocation. In general, the more savings you have, the more you can afford to diversify among different asset types. Select the current value of all savings and investments that you have set aside specifically for retirement. Include retirement accounts and exclude your primary residence.
What is the total of these savings?
10. Unexpected Expenses
With an ample emergency fund (three to six months of expenses), you're much less likely to need your retirement savings for unexpected expenses. Without such a fund, you're putting your retirement savings at risk, which may decrease your investing time horizon. For quick, easy access to this emergency money, keep it in very short-term investments, such as cash equivalents.
Do you have a separate emergency fund?
11. Expected Expenses
You might be planning to withdraw some of your retirement savings for nonretirement expenses. The sooner you need this money, the more your savings should be in readily accessible investments, such as cash equivalents. (Remember that taxes are due and IRS penalties apply to many early withdrawals of retirement savings.)
In the next ten years, do you expect to withdraw from your retirement savings for nonretirement expenses?
12. Future Financial Situation
Your future financial situation (the ability to meet your expenses, job stability, and future earnings) is another indicator of how likely it is that you will need to withdraw your savings for unexpected expenses. In general, the more stable your situation, the less likely this is to occur, which suggests a more aggressive investment approach.
In the future, I expect my financial situation to be:
Won't lose sleep at high levels of risk.
Choose Your Investments >>
High levels of risk are acceptable in seeking out potentially higher returns.
Some safety is good, but will accept moderate levels of risk.
Choose Your Investments>>
Willing to take some risk, but still need a sizeable anchor of safety.
Low risk tolerance. Safety is important, but willing to invest in riskier areas on a limited basis.
Large-cap stock funds
Mid-cap stock funds
Small-cap stock funds
International equity funds
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This is for informational purposes only and is not intended to constitute legal, financial, or tax advice. Certain recommendations or guidelines may not be appropriate for everyone. Consult your personal advisor or attorney for advice specific to your unique circumstances before taking action.