You: How can I determine how much risk to take when investing?

The appropriate amount of risk you should take depends on several factors, as we discuss in Beyond Paycheck to Paycheck. One of the most important considerations, however, is your risk tolerance.

You: My risk tolerance? Last week, when I was out with a bunch of friends at “Rick’s,” I had 7–

Nope. This is an entirely different kind of risk tolerance. We’re talking about your tolerance for investment risk, not alcohol-related hazards.

The only way to know your true reaction to losing money is to actually lose money.

You: Okay.

So go lose some.

You: What?

Gary: This guy is nuts. Why are you still reading his blog?

Cool it Gary. I’m just kidding about intentionally losing money, of course. But when you lost money investing, as all investors do periodically, how did you react?

You: I’m not sure how to answer that question.

Think about it like this:

  • Did you buy more of the declining investment?
  • Did you pull your money out?
  • Did you sit tight and do nothing, but find that you had developed a twitch on the left side of your face?

You: That was unrelated! Who told you about that? Those stupid web-cams!

Just a lucky guess. But it is your real-world reaction to losing your money that enables understanding of your true investing personality. Many web sites, like MSN Money and Bankrate, offer short quizzes to help you measure your risk personality. These anonymous quizzes are worth the time–take one or two. But they are no substitute for real-world experience. So unless you are unusually confident, remember strategy # 1: Walk. Then run.

Now that’s living Beyond Paycheck to Paycheck.

Gary: You’re just chicken. You’ll never get anywhere taking quizzes. You’ve got to move quickly in this world people!

Ahem. What’s your net worth, Gary?

Gary: I’m sorry–can’t talk right now. Got a margin call to deal with.

You: What’s a margin call? Sounds scary.

Stay with me and it’ll never matter.

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