The first step towards being a successful investor is knowing yourself. Your financial needs, intellectual curiosity and emotional reactions are all factors in what kind of investor you are, and therefore what types of investments are appropriate for you.
The quiz below is designed to give you a general idea of your risk profile as an investor. While the scoring is not an exact science, the issues raised by this quiz should help you think about the nature of and your comfort level for investing.
Questions to determine how much investment risk you're willing to take
In answering the quiz below, award yourself 1 point for each choice "A" you make, 2 points for each choice "B," 3 points for each choice "C" and 4 points for each choice "D." At the end of the quiz you will see some guidance on how to interpret the score you received. High or low scores are neither good nor bad; they just indicate where you are on the risk spectrum.
1. When you will need to access a substantial portion of this money?
A. Soon, within the next year.
B. Probably between 1 to 5 years.
C. Most likely within 5 to 10 years.
D. Not for at least 10 years.
Timing is everything - if you need the money soon, that may outweigh any other inclination you have to take more risk.
2. What magnitude of decline in the value of your portfolio would make you feel very uncomfortable?
A. I could not tolerate any loss of value.
B. I could tolerate a moderate decline of perhaps 5 or 10 percent.
C. I'm prepared to ride out periodic market declines, even fairly serious ones.
D. I'm prepared to take the risk of permanent losses for the sake of a chance at high returns.
Investments can be anywhere on the spectrum from fully guaranteed to carrying the possibility of total and permanent loss. Always consider the worst-case scenario before investing.
3. Have you invested through a significant market correction before (i.e. seen investment declines of 15 percent or more)?
A. No, I am new to investing.
B. I've been investing for a few years now, but I haven't gone through that kind of market decline.
C. Yes, I have experienced a bear market before.
D. I've been an active investor through multiple cycles of bull and bear market phases.
Theory is one thing, reality is another. Investors often learn a lot about themselves by going through adversity.
4. How have you typically reacted to market corrections in the past?
A. I've either never experienced a correction, or when I did, I liquidated to guard against further losses once I saw my portfolio's value going down.
B. I rode out the bear market, but I don't want to go through that type of thing again.
C. I stayed the course, and would be prepared to do so again.
D. As the market went down, I was a buyer rather than a seller so I could take advantage of lower prices.
During market declines, there are sellers, holders and buyers. Your reaction under those conditions says a great deal about your tolerance for risk.
5. Are you regularly contributing to this account, or drawing from it?
A. I draw from this portfolio regularly, at least 4 percent a year.
B. I neither put in nor take out much money, less than 4 percent annually either way.
C. I make regular, moderate contributions, representing between 4 and 10 percent of the portfolio's value annually.
D. I am saving enough to add to this portfolio at a rate of 10 percent or more per year.
Negative cash flow exposes you more to market fluctuations, while positive cash flow can actually help you benefit from them.
6. What portion of your assets does the current investment you are considering represent?
A. Over 50 percent.
B. Between 25 and 50 percent.
C. Between 10 to 25 percent.
D. Less than 10 percent.
The risk of any given investment should be viewed in the context of the rest of your assets. The smaller an investment, the less harm it can do.
7. Have you taken any coursework in economics or finance?
B. Yes, at the high school level.
C. Yes, I've taken some courses in these subjects in college or grad school.
D. Yes, I have a degree related to these areas.
The more you know, the more informed your decisions about risk will be.
8. Do you feel comfortable you fully understand financial instruments before you invest in them?
A. No, I just don't have the time or the inclination to learn about how they work.
B. Not really. I've tried to research them a little, but I don't feel I really get it.
C. I think I know the basics of stocks and bonds, just not some of the more complex strategies.
D. I think I have a good handle on everything from fundamental research to various options strategies.
Not everyone has a natural aptitude for investing, so be careful of taking risks you don't fully understand.
Scoring for quiz results
These results (out of a total of 32 points) should not be considered definitive, but they can give you a broad indication of what types of investments you should be considering.
Low-risk investor: 8 to 16 points
For your needs and attitudes, you may be better off sticking to FDIC-guaranteed deposit accounts like savings accounts and money market accounts. You might also be able to earn a little more interest by taking advantage of CD rates, if you can match the length of the CD up with the timing of your cash flow needs. Just be prepared for the fact that because of your emphasis on stability, your investments won't earn much.
Moderate-risk investor: 17 to 24 points
You seem to have enough risk tolerance that you should be able to consider both long term CDs and diversified portfolios with a mix of stocks, bonds and cash equivalents. You should be looking at online brokers or discount brokers that offer a wide range of diversified mutual funds with reasonable expense ratios.
High-risk investor: 25 to 32 points
Your circumstances and attitudes seem to suggest you are comfortable with higher risk investments, such as individual stocks (as opposed to diversified mutual funds), options and possibly even margin trading. You may want to consider online stock trading for more immediate access, and you should look for discount brokers with low commissions. If you plan to trade on margin, the margin rate the broker charges should also be a consideration.
Finally, remember that your risk profile at any one point in time does not define you for the rest of your investing career. As your needs change and experiences shape your knowledge of and attitude toward investing, be prepared to adjust your risk profile accordingly.