Having a good understanding of your own risk tolerance will enable you to understand your ability to take risk. Of course, everyone has different risk tolerances and there may not always be a perfect personality type or category to place everyone in. The CFA Institute compares the risk attitudes and decision-making styles among distinct investor personality types, and lists the four main personality types as cautious, methodical, spontaneous, and individualistic investors. The below table is just a rough gauge for you to better understand your psychological profile.
Before deciding which category you belong to, you may want to do a little personality test to give you further insight. After all, don’t you want to know how your background can form the type of investor you are now? Think about your life experiences, inherited behavioural traits, career paths, and your current investment portfolio (if any) to decide on your willingness to take risk. Do you think these decisions would be influenced by your emotions?
You just stepped into the workforce and with income streaming in, you are eager to take a dip into the investing pool. Of course, being young and a greenhorn in the workforce doesn’t give us an excuse not to manage our finances. But with numerous options out there, you find yourself drowning in information from just trying to understand those options before you even begin. Because you do not have any spare savings to rely on, your decisions are likely to be made primarily from feelings. That is why you could be very sensitive to investment losses. Your risk tolerance is low and your investing style is emotional to a large extent. As you learn along the way, you could either become a validation seeker, adventurer, or the DIY guy. But for now, you are likely to belong to the cautious personality type. This personality type could also belong to retirees who are unable to withstand too much volatility.
THE VALIDATION SEEKER
You already know how to handle your own finances through investing and you become more well-informed because you seek out facts. Even though you rely heavily on investment research, with many options out there, you can’t help but seek for an opinion to validate whether you are making a right choice. It shows that you are still uncomfortable dealing with volatility because you fear the uncertainty. Take extra precaution when investing. Your risk tolerance is low and while you may let emotions take control, your investing style has become more cognitive than before. It is your disciplined investing that cause you to have a lower risk tolerance. Of course, you are more than willing to accept a lower return even if it means lesser risk.
Unlike the greenhorn, you see a world of opportunities. Investing is fun and you dive in headfirst. You are open to learn about any investment option that comes your way and you are confident about finding your own investment style through learning. If active trading becomes your style of investing, your risk tolerance grows higher and your investing style could become more spontaneous. You accept higher risks in return for its potential for higher returns and while your portfolio may be diversified, it has a high turnover rate as well. You are likely not seeking further advice because you are looking for an edge to gain higher returns. Chasing fads for fear of not missing out may get you more emotional when investing too. Fear and greed are likely to take control.
THE DIY GUY
Lastly, we have the individualist DIY guy. You invest with confidence, that’s why you don’t need the help of any brokers. You see online trading as ideal because you not only get to take control, but you do it without the brokerage fees and what not. You are well-informed because you seek out facts and you become self-assured as a result. Your risk tolerance is high and your investing style is rational. You know when to accept higher risks in return for its potential for higher returns and when accept a lower return even if it means lesser risk.
Now that you know how your personality type influences your willingness to take risk, you can better judge your ability to take risk. Like what Warren Buffet says, “To be a successful investor, you must divorce yourself from the fears and greed of the people around you, although it is almost impossible.”
As tempting as it may be, do not allow yourself to be controlled by fear and greed.