Risk cannot be avoided. Putting your money in a mattress risk actual loss of the money. Depositing money in the bank risk a loss of purchasing power of the money to inflation. Risk must be identified and understood before it can be managed.
Investment theory and historical capital market return data suggest that, over long periods of time, there is a relationship between the level or risk assumed and the level of return that can be expected in an investment program. In general, higher risk (e.g. volatility of return) is associated with higher return.
Given this relationship between risk and return, a fundamental step in determining the investment policy for the Portfolio is the determination of an appropriate risk tolerance. There are two primary factors that affect the Investor’s risk tolerance:
- Financial ability to accept risk within the investment program, and;
- Willingness to accept return volatility.
Speculative risk level:
The possibility of a total loss of capital in any one investment in any given year.
Aggressive risk level:
The possibility of a loss of 30 to 50% of capital in any given year.
Businessman’s risk level:
The possibility of a loss of 10 to 20 % of capital in any given year.
Modest risk level:
The possibility of a loss of 5 to 10 % of capital in any given year.
Low level of risk:
The possibility of very little loss of capital in any given year.