Generally speaking, the riskier an investment, the higher it's expected return will have to be in order to entice investors. Determining how much risk to accept in your investment portfolio depends on two broad factors:
- what are the inherent risks of the particular investment, and
- how able and willing you are to deal with these risks (this factor is known as "risk tolerance")
Risk tolerance. When you evaluate the level of your personal risk tolerance, here are a number of things that you will want to consider:
- Family situation: A stable marriage and good health may allow you to assume a bit more risk than if you are contemplating a divorce or separation or are experiencing the physical, mental, and economic effects of health problems.
- Age: In general, the older you are, the less risk you may be willing to tolerate, since you are closer to the time when you may need to start living off your investment fund income (and possibly principal), and have less time to overcome the impact of investment "mistakes."
- Business/employment situation: A sufficient and stable stream of personal income provided by your business, outside employment, or spouse's income can go a long way toward giving you the flexibility to go for higher-return (and more risky) investments. For example, if your spouse has secure employment outside your business that provides a salary of $50,000, and employer-provided medical and retirement benefits, you might feel freer to go for more risky investments than you would if your business were the only source of your family's income.
- Debt and liquidity: If you have a comfortably large fund of cash and other liquid assets to get you through a financial emergency, you probably will feel more prone to accept more investment risks than if you didn't have such a fund, or if you were burdened with a high level of debt.
- Other investments: If you already have fixed-income and/or other conservative investments, you may be better suited to assume more risk than if you are currently heavily invested in high risk investments.
- Insurance: Investment risk is not the only risk you face; you are confronted with risk of loss because of accident, ill health, disability, and premature death. If you have adequate insurance to indemnify yourself or your family on the occurrence of these risks, you have less of a need to have a large "self-insurance" fund of liquid assets. Because of this, you may feel free to move to higher return, higher risk investments.
- "Just you" factors: This is last on the list, but certainly not least important. Despite what anyone tells you about the safety and return of an investment, you have every right to take a pass on any investment that unduly raises your anxiety levels. No matter how safe an investment may be from an objective viewpoint, or how much income it may generate, you probably won't find it worth it if worrying about it threatens your health.