I’m often asked how one should determine his or her risk tolerance for investing. Many “tests” are available on the Internet. The following quiz, which I use with my clients, may be helpful when trying to answer this question. If you have a partner, it may be interesting to take this quiz separately and then discuss your answers.
1) A month after you purchase a stock, its share price rises 50 percent. You can’t find out why it rose so dramatically. What would you do?
a) Buy more – it may go higher.
b) Hold on to what you have hoping for a further gain.
c) Sell immediately.
2) You inherit your mother’s beach house, mortgage free. It has become run down, but beach property continues to appreciate. You could rent it as is for $1,200 a month, or renovate it and rent it for $1,800. You would have to take out a small mortgage on the property to finance the renovations. You:
a) Take out the mortgage and renovate the beach home.
b) Rent it as is.
c) Sell it now – rental property seems like a hassle.
3) Your best friend wants to start a business, but she needs some capital for startup costs. You think her new business idea has real potential. She wants you to invest $40,000 (which you currently have), in return you would own 30 percent of her company. If everything goes as planned, you could get back 40 times your investment in three years. On the other hand, four out of five small businesses fail within the first three years. What would you invest?
a) Nothing at all and wish her well.
b) Tell her you will work with her and try to get financing through some conventional means. Invest no money.
c) Invest $20,000.
d) Invest the $40,000, and if things seem to be going well, tell her there is more where that came from.
4) You go to Las Vegas with friends and lose the $300 you had allocated for gambling. What do you do?
a) Quit gambling and enjoy the other activities.
b) Decide $100 more may just win your $300 back.
c) Notice that one of your friends lost $600 before winning it all back, and allocate another $300.
d) Throw caution to the wind – the more you lose, the better the chances of winning!
5) An investment loses 14 percent of its value less than a month after you buy it. The fundamentals of the investment and your financial goals have not changed. You:
a) Hold on to the investment.
b) Sell it – you’ve worried enough.
c) Scrape up some money and buy more – if it looked good before, it’s a great buy now.
6) The small computer company you work for is raising money by selling stock to employees. If you buy the stock, you will not be able to sell it until the company goes public. Management plans to go public in three years. You like the company and feel that if things continue as they are, and it goes public, the share price could be 20 to 30 times higher than what you would have to pay now. You are also aware that the company might never go public, making your shares worthless. How much would you invest?
b) One to two months salary
c) Six months salary
d) Borrow as much money as you can – this is the opportunity of a lifetime.
7) You are on a TV game show and must decide whether to go on or take your $10,000 winnings and quit. You:
a) Take the money and run.
b) Take a 20 percent chance of losing it all but winning $50,000
c) Take a 50 percent chance of losing it all but winning $75,000
d) Take a 90 percent chance of losing it all but winning $100,000
8) You decide to invest in a stock fund for a long-term goal. You choose:
a) A stock fund with a long, stable performance track record. It is never the best-performing or the worst. It invests in large, well-known companies that pay dividends.
b) A stock fund that is only three years old but has outperformed all similar funds by 8 percent for the past two years. It invests in small, unknown companies.
c) Both. You divide your money between the two funds.
9) What would you be more excited about:
a) You win $1,000 by being the 15th caller on a radio show.
b) Your grandmother sends an unexpected gift of $1,000.
c) A risky $100 investment you made last year returns $1,100.
d) $1,000 is $1,000 – you’re excited no matter how it came to you!
Note to readers: Contribution limits for Roth and Traditional IRAs have increased by $500 for tax year 2013. Those 50 and older may contribute as much as $6,500, and those younger than 50 may contribute as much as $5,500 or earned income, whichever is less.
Holly Nicholson is a certified financial planner in Raleigh. She cannot answer every question. Reach her at askholly.com or P.O. Box 97128, Raleigh, NC 27624