Today’s post is by my awesome staff writer Jordann. Enjoy!
One of the best things about personal finance is that it’s so personal. Everyone has their own strategy, tailored to their own specific personality. I think this is why there can be so many personal finance blogs out there, yet somehow we all still manage to come up with unique and interesting content day in and day out.
If you’re anything like me, it’s the personal stories that keep me coming back, not the generic posts about maintaining a reasonably sized emergency fund.
One of the things I love reading about is risk tolerance. It’s so interesting how this personal threshold is so different for each individual. Myself, I’m not a risk taker. Instead of investing my income, I’m choosing to take a guaranteed but modest 5.5% return by paying off my student loans. After that, I’ll be paying off my low-interest car loan, and beefing up my emergency fund until it reaches 3-6 months of expenses, and saving for a 20% house down payment.
I don’t like being in debt, and I’d rather spend my money limiting my vulnerability than investing for a much higher potential return. Heck, even the idea of buying a house, and tied to such a huge mountain of debt, makes me squirm, even though it would be an asset.
I’m one end of the spectrum. At the other end, you’ll find people who are much more daring than me, and who, as a result will probably end up a lot more wealthy than me. These people are comfortable with maintaining debt in favour of investing their cash flow for higher returns. These people carry multiple mortgages for rental income, and are willing to take risks with their capital for the possibility of higher returns. Lots of these people are entrepreneurs, which in my opinion, is one of the biggest risks a person can take.
Determining Your Risk Tolerance
Neither end of this spectrum is necessarily the best place to be, and there is a ton of grey space in between. Knowing where you fall on the risk tolerance scale is important, and can influence your financial habits in a huge way. From the size of your mortgage to the expected rate of return on your retirement savings, determining your risk tolerance level when it comes to your finances should govern almost every financial choice you make.
I won’t go into how to figure out what your risk tolerance level is, a quick google search yields a bunch of great articles and quizzes on figuring that out. I will say that it’s important to take your risk tolerance into consideration when making financial choices.
One Person’s Risk is Another Person’s Reward
Imagine if I suddenly decided that I was going to follow a formula for how to make my financial decisions, without giving any thought to my personal preferences for risk. According to conventional wisdom, I might still pay off my student loans, but I might not bother to pay down my car loan or buy insurance and instead start saving more aggressively retirement. I might also put down 5-10% on a house instead of 20% in order to take advantage of historically low-interest rates.
While this might sound like a perfectly reasonable plan for someone in the middle of the risk tolerance spectrum and positively boring to the world’s risk takers, to me, this plan is a recipe for sleepless nights and worry. By not factoring in my risk tolerance, I’d be setting myself up for failure from the start.
Heed Your Personal Risk Tolerance
Personal finance is personal. This has got to be one of the favourite sayings in the personal finance community, usually to justify a bad purchase of some kind. In this case, however, it’s true.
Know your risk tolerance level, own it, don’t feel guilty about it if you’re like me and hate risk, and DEFINITELY don’t ignore your risk tolerance level when it comes to making financial decisions!