Blog | Investor, Know Thyself
tl;dr
Investing can be brutal. You're way better off if you figure out 2 things before you start:
Your risk tolerance How much $$ are you willing to put at risk at any given time?
Your time horizon When are you going to want to pull money out of the market?
Last week we outlined a strategy for independent investors called 7 Principles of Successful Investing.
Try as we might, we couldn’t fit it all into one post, so we’re gonna break this down a little further, starting today. Here’s Principle № 1: Investor, Know Thyself.
🔎 Learn more: this post is extracted from 7 Principles of Successful Investing, available on Udemy from Dr. Richard Smith 🔗.
Do this before you invest
Most independent investors get into the markets without any training—which leads directly to losses. Evidence for this effect is everywhere.
Because there’s no real barrier to investing. If you’ve got a few bucks, no online broker is going to turn you away.
Here’s the minimum that you should know before you put any money in the markets:
Your risk tolerance
We can break this into 3 levels: conservative, moderate, aggressive
Your time horizon
3 levels here, too: short-term, intermediate-term, long-term
Given those 3 levels for each, you’ve got 9 scenarios:
Find out where you fall on the grid of risk tolerance: conservative / moderate / aggressive, and short-term / intermediate-term / long-term.
How to find your risk tolerance
There’s no industry-wide standard when it comes to risk tolerance, so we’ll run with the three-part breakdown we described above. Here’s what they mean:
Conservative
You’re looking for steady, reliable earnings. You’re not going to chase memestocks. You’ll leave YOLO strategies to someone else. At minimum, you want to match the performance of the market.
Moderate
You definitely want to beat the market—maybe even catch a few steep rises—and you’re OK with putting some of your wealth at risk to get there. You can weather some losses, if you need to.
Aggressive
No question, you want to beat the markets. You’re ready to choose a bunch of less-sure bets and see which ones take off. You know that losses are going to be a part of that.
🚨 Important: 🚨
Don’t automatically choose “Aggressive” because it seems cooler, or like your returns might be better. Memestock madness in spring 2022 saw a ton of investors deciding to get aggressive all of a sudden, when they really couldn’t afford to.
There are a ton of Risk Tolerance quizzes out there that can help you choose one of those 3 lanes.
This one from the University of Missouri is the standard. It takes about 10 minutes to complete, but at the end, you’ll know for certain where you fall.
Preview the University of Missouri Risk Tolerance Assessment for financial planning.
How to find your time horizon
This is actually a less exacting than risk tolerance; there isn’t any online quiz that can tell you what to look for. But here’s a handy guide to get you started:
Short-term
When we’re taking about investing (as opposed to trading), short-term means that you plan to hold your investments for about 9–12 months. That might feel like a long time, and by some measures it is, but if your plan is to build wealth for life, these are the kinds of time-scales you need to think of.
Intermediate-term
Now we’re talking about 18 months or more. This is for those of you who have a financial target (buying a house? having a kid? getting a truly legendary pair of kicks?) in the next couple years, and want to get into the markets and then out again with a bit more capital.
Long-term
This means you hold your investments for at least 3 years. You’re probably not intending to take your money out of the markets until you hit a significant life goal, like retirement.
GIF of Ron Swanson from Parks and Recreation, saying "I know what I'm about, son" at JJ's Diner.
Alright, I know myself. What now?
Once you’ve found your spot on that grid, you’re ready to go into research mode. You know how you’re going to invest. Now to find out what to invest in.
We’ll go there later this week with Principle № 2: Believe in What You Buy.
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time horizon - The amount of time one expects to hold an investment. It is most often used to describe the date target when an investor intends to pull a significant amount of money out of the markets, or get out of the market entirely.
Other posts that mention terms time horizon
Believe in What You Buy
Dr. Richard Smith
7 Principles of Successful Investing
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