Barbara O’Neill, Extension Specialist in Financial Resource Management
Rutgers Cooperative Extension
Two Tools to Assess Your Investment Risk Tolerance
Investment risk tolerance can be defined as the amount of volatility (i.e., change in the value of an investment) that an individual is willing to withstand, particularly on the downside (i.e., loss of money). It has sometimes been referred to as an individual’s “sleep at night factor” as in how much investment risk are people willing to take before they are awake at night worrying about the status of their investments? Like values and goals, investment risk tolerance varies among individuals and there is no “right” or “wrong” risk tolerance level.
Various quizzes and tools are available to assess investment risk tolerance. Some ask people about investment decisions that they have made in the past, some ask them to respond to hypothetical scenarios that involve investment risk, and some do both. Quiz providers include universities, government agencies, banks, mutual fund investment companies, and brokerage firms.
What factors determine investment risk tolerance? This question is the subject of much research so there is no definitive answer. Not all factors related to investment risk tolerance are financial ones, however, such as income and net worth. An investor’s knowledge about investing, previous investment experience, age, income, assets, gender, ethnicity, and attitudes about risk-taking in general can also influence risk tolerance. In addition, risk tolerance levels associated with investments may be associated with other types of risk-taking behaviors in life such as fast driving and participation in extreme sports.
Rutgers Cooperative Extension has a simple online Investment Risk Tolerance Quiz available at http://njaes.rutgers.edu/money/riskquiz/. The quiz, developed by Dr. John Grable at the University of Georgia and Dr. Ruth Lytton at Virginia Tech, includes 13 questions and provides users with feedback about their capacity to handle investment risk. Data collected from users is also used for investment risk tolerance research. The higher the total score, the higher someone’s investment risk tolerance. Quiz questions are based on both thoughts about risk in hypothetical situations and current investing behavior.
Want to test your investment risk tolerance level in a fun and creative way? Go to The Balloon Test web site developed by Barclays at https://privatebank.barclays.com/private-bank/en_ch/home/thought-leadership/helping-you/to-risk-or-not.html. Click “Start” to begin a series of decisions that link the process of pumping up a balloon to the holding period on investments.
Decide when (i.e., for how long?) to keep pumping a balloon to earn 50 points for each pump. This is like earning money on an investment. Decide when to stop pumping to collect your points, ideally before the balloons burst. This is like selling an investment for a profit.
At any time your balloons can burst, however, and make a loud popping noise (if sound is turned up on your computer). This is like losing money on an investment.
Play the game for five rounds. This is like investing for the long term where investment results can vary. Compare your total points to the baseline data and answer the following questions:
What was the highest and lowest number of points that you received on the five rounds of play?
How did you feel when your first balloon burst?
Did having a bubble burst change your behavior on subsequent rounds of play (i.e., future decisions)?
Did having a “good run” without balloons popping change your behavior on subsequent rounds of play?
How would you assess your risk tolerance as an investor?
What did The Balloon Test activity teach you about investing in stocks or stock mutual funds?
For more information, here is a list of the steps involved in using this interesting interactive activity.
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