Stock Investing Basics: Chapter 6 -- Goals, Risk Tolerance, and Objectives

Chapter 6
Goals, Risk Tolerance, and Objectives

At its most basic level, investing in stocks, or equities, is exchanging your some money now for more money later and if you choose your investments wisely, you can earn 8, 10, 12, or 15 percent annual returns, or more.

If you had invested $1,000 in Wal-Mart in 1971, you'd now have well over $2 million. Now, hindsight is 20-20, so its safe to say that you don't even know what the next Wal-Mart, Dell, Microsoft, or Google might look like. (If you do, tell me!)

You, and ONLY you, can determine what your goals are, how much risk you can tolerate, and how you can best get to where you need to go without driving yourself batty.

Here are some things to consider. First, it's riskier NOT to put your money in an equity. Here's why: Inflation. Inflation is the tax on everyone and everything that reduces your wealth every single day. If you're not earning at least the inflation rate in your savings and investments, you're losing money. Typically, this meant you had to earn, after taxes, at least 2-3 percent every year. Currently, savings accounts are yielding 3 percent and inflation rose at a 12 percent annual clip last month (1.1 percent for the month); you lost 9 percent.

You also have to take into consideration your risk tolerance. Ask yourself this: If I were to invest in company XYZ, and it lost 50 percent of its value overnight (or just pick WM, which has lost 90 percent in one year and whose dividend was cut twice, all the way down to a penny), how would you feel? Would your blood pressure rise precipitously? Would you toss and turn at night, unable to sleep? Or, would you chalk it up to a lesson learned and go on your merry way? (Remember Axiom #1!)

Now, how do you propose to get from A to B and all the way to your ultimate goal of Z? Only by balancing your goals and risk tolerance, taking into consideration all the market forces and stock fundamentals, can you succeed.

The easy way is to allocate more than you need and accept lower returns with lower risk. This brings us to a concept called the “Risk/Reward ratio,” which is your personal tolerance for risk given a return, or conversely, your expected return for a given amount of risk.

Many people have little patience for the ups and downs of the stock market; they simply want to put their money somewhere and let it grow. Investments that may be suitable to these types of folks are saving accounts, bonds and bond funds, or index funds that attempt to mirror an entire “market” or index like the S&P 500 (listed in order of riskiness).

Later, we'll talk about Scenarios and how this balance between risk and reward factors into your investment portfolio.

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