What your broker doesn't want you to know
Step 3     Risk Tolerance
The next step, determining your risk tolerance, can be a little daunting since you may have no idea what that means. Basically you need to assess how much of a roller coaster you’re willing to tolerate, i.e. a portfolio that goes up and down a lot. Here are some risk tolerance questionnaires that might help you formulate your thoughts on your own willingness to endure market volatility.

Why does it matter how much risk you can bear? More or less, financial markets pay you for the strength of your stomach lining. The more lurching up and down over time that you can tolerate, the higher return you can earn, at least theoretically. The real test will be how you behave during a big market drop like the bear market from 2000 to 2002, when the U.S. stock market lost about half of its value. Try to be honest with yourself and picture how you’ll really behave during the next big drop. Of course, we don’t know when that drop will come, but if you’re a long-term investor it’s almost certain that a big drop will come at some point.

Later I’ll recommend some typical portfolios based on your time horizon, but you may need to adjust those upward or downward depending on how much volatility you can bear.

View a Video Clip on Risk Tolerance.

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