Every financial decision we make comes with some level of risk, but not all risks are created equally. So how do you determine if an opportunity is worth the level of risk it requires?
There’s no one right or wrong way to approach risk as an investor, but it’s important that you think critically about what risks you take, when you take them, and how they may impact your journey to achieving your goals.
With that in mind, here are three important questions to ask yourself before taking a risk.
1. Does the Idea of Uncertainty Excite Me or Make Me Anxious?
This question can help you determine your level of risk tolerance, or your ability to handle uncertainty.
If you’re someone who thrives on the idea of possibility and is comfortable with the unknown, you may want to invest more aggressively than someone who is stressed out by the idea of unknown outcomes.
Remember that it’s OK to prioritize your own peace of mind. Investing should get you closer to the life you want, not further away from it. So if you find yourself losing sleep over your investments or experiencing high levels of anxiety around taking a specific risk, that investment may not be worth it for you.
2. Does this Opportunity Get Me Closer to My Goals?
A risk is only worthwhile if it’s helping to move you closer to your goals.
Say, for example, that you have a major expense — like paying for your child’s college education — in the next 3-5 years. It usually won’t make sense to invest that money in a high-risk opportunity, because if the investment underperforms, you won’t have time to earn the money back.
If, on the other hand, you’re investing for retirement in 20-30 years, you may be able to comfortably take on a higher level of risk, knowing that many investments perform better over the long-term.
3. Is Now the Right Time to Take a Risk?
Just because a risk aligns with your goals and your comfort levels doesn’t necessarily mean that you should take that risk today. Take a moment to consider how this new opportunity would fit within your broader investment strategy.
If you have a large portion of your portfolio tied up in an illiquid investment for a certain number of years, you’ll likely want to prioritize lower-risk investments for the rest of your portfolio during that time period.
You should also remember that no investment happens in a vacuum. Certain opportunities will have higher risk depending on when you take them, like investing in real estate when the market is peaking.
If you’re unsure about the right time to invest in something new, consider reaching out to trusted advisors or other people in your network for insight.