Asset Allocation Based on Your Risk Tolerance

Don't confuse risk tolerance with risk aversion. No sane person wants to take risk for the sake of taking risk. Sane people are risk averse. Some are more averse than others. Risk tolerance is quite something else—although there might be a connection.

Risk tolerance is the amount of risk you can afford to take when selecting your investment options. The more risk you can afford to take, the less averse you feel about risk. It is a key factor in building the investment portfolio that is right for you. Acting outside of your risk tolerance level could result in sleepless nights worrying about a rash decision you made.

Often, an investor's ability to meet current financial responsibilities regardless of the results of his or her investment will influence his or her aversion to risk. If you have a high net worth and can afford to lose some of your invested money, you may feel comfortable speculating in potentially volatile investments such as currencies, options, futures, and forward contracts. Conversely, if you have a low tolerance for risk (or few dollars to spare), it may be wise to stick to conservative investments.

When making asset allocation decisions, consider your risk tolerance as well as your risk aversion. It will help you make wiser investment decisions.

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