A good understanding of your goals, priorities and
personality will help you develop a successful and comfortable
investment style. Three factors are key: your risk tolerance, time
horizon and tax liability.
Risk
What's your tolerance for risk? Your attitude will
help dictate the types of investments best suited to your
situation and your personality. For example, some people
can't sleep at night if they believe their investments may
lose value. Yet others are comfortable with investments that may
be volatile but also have the potential for aggressive growth.
Financial planners frequently use five categories to
define risk tolerance:
Conservative income — oriented investors — seek to
preserve principal above all else, with asset growth a secondary
priority.
Moderate income-oriented investors — seek to generate
and maintain steady income at the expense of little, if any,
asset growth.
Conservative growth-oriented investors — seek to
increase portfolio value while producing a moderate amount of
income.
Moderate growth-oriented investors — seek to grow assets
and income while tolerating moderate fluctuations in value.
Aggressive growth-oriented investors — seek to maximize
returns while tolerating a high fluctuation in asset value.
Time horizon
How much time do you have before you'll need to draw
on your savings? Your answer will help determine which investment
vehicles are most appropriate. Generally speaking, the longer you
have until retirement, the more you should invest in growth
securities. As you draw closer to retirement, most advisors
suggest shifting a larger portion of your portfolio into more
conservative investments.
Some experts go by this rule of thumb: the percentage of
your investments in growth securities should be equal to 100 minus
your age.
Taxes
Finally, your tax situation will influence the allocation
of assets. For instance, should you consider tax-free or
tax-deferred income? Do you expect your tax bracket to increase or
decrease? Your answers will dictate where you should invest at
least a portion of your portfolio.
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