How Risky Are You?: Assessing Your Risk Tolerance

Risk and Investment: 

Each of us would probably say we would tolerate a risk if a good return was guaranteed.  But if the return was a guarantee, would it really be a risk?  Risk is defined by dictionary.com as: “exposure to the chance of injury or loss; a hazard or dangerous chance.”  With risk, there is always a possibility of loss or for things to not work out as planned. I’m sure I’m not telling you anything new here. Much of life is a risk! 

If you invest in real estate, or any asset for that matter, you’re going to risk some financial security, which can be scary. Before we spend more time discussing risk, however, let’s first define what an “investment” is. Dictionary.com defines it as: “the investing of money or capital in order to gain profitable returns, as interest, income, or appreciation in value.” That sounds like a good deal!  Looks like we just put capital into something and then the return comes out the other end. Oh, if only it were that simple! Of course, we all wish we could trust someone with our capital and obtain a guaranteed return. However, the reality is quite the contrary: investments are often not guaranteed. 

So, what is the difference between risk and investment? Practically speaking, sometimes not much. I think the best we can do is embark on due diligence, investing time and research into an investment until we feel it is a “calculated risk” and can experience a peace about it. Due diligence involves a thorough amount of research on an opportunity until you develop a working knowledge of the concept. This process can occur in many ways: discussions, article readings, books, case studies, etc… The main point of due diligence is to prevent passive bystanding and promote true engagement as you actively search out the potential risks and rewards of an opportunity. Only after you complete due diligence can you face the difficult decision of whether or not to invest your hard-earned money in the opportunity you’ve spent time working on. No pressure, right? 

Assessing Risk Tolerance: 

To get started on your due diligence process, you first need to figure out your risk tolerance. If you’re married, you also need to figure out your spouse’s risk tolerance. When I talk to couples interested in real estate investing, I often find that either the husband or the wife is a little more resistant to investing. One is typically very much for it, while the other is skeptical (at best). 

The truth is, if you’re going to have long-term success in an investment strategy, especially when it comes to real estate, you need to address your risk tolerance and your spouse’s risk tolerance early on in the process. If you don’t address risk tolerance, it’s likely that your marriage will experience strain, and it’s not worth investing if your relationship gets harmed in the process. 

Simply put, it’s important for you and your spouse to be on the same page. Something that helped my wife Laura and me was listening to the book Rich Dad Poor Dad by Robert T. Kiyosaki and visiting with other people we knew who had rental property. 

When discussing risk tolerance, it’s also important to keep in mind that some people have varying levels of tolerance depending on the type of investment. For example, some people may have had a bad experience with rental property, or they may not feel like they have the knowledge necessary to maintain or operate rental property. Perhaps you have no idea how to repair or diagnose the issues of a house. You may even fear being taken advantage of if you embark in real estate investing. I think that’s a legitimate risk and concern, especially early on. Sure, you can learn all those things, but it’s important to be honest with yourself when assessing such risks. On the other hand, you may be the opposite and hold more trust in real assets. Rather than trusting the stock market, you may feel more confident in your real estate property. Whatever the case may be, people have differing comfort levels when it comes to different investments, and I think all of that is legitimate. 

So, when assessing risk tolerance, I would recommend asking yourself (and your spouse) the following questions: 

1. What investments do you feel most comfortable with? Or, what type of investments are most appealing to you? 

Some people may be most comfortable with investing in rural land and just holding it, for example. This way, there are no renters involved, you still get long-term appreciation, and you may even enjoy hunting or camping on the land. Rural land or not, there are a ton of investment strategies and options that are important to know your and your spouse’s comfort level on and attraction to. 

2. What is your greatest fear in taking on real estate investing? Or any investment? Can you explain why? 

After identifying your fears, ask yourself a follow up: If I had more knowledge, could I alleviate these fears? It’s also a good idea to talk to people with experience and see if that makes you feel any better about your concerns. 

3. What amount of capital do you feel comfortable in investing? Why? 

If you are hesitant to go all in but are still willing to risk some money, you may be able to handle the risk with a more bite-sized investment around $15,000 to $20,000. Or, instead of buying 10 houses, just roll with one and see how it goes. Taking incremental steps is important in real estate investing—don’t get in too deep where you’ll regret it later. 

4. Can you think of something better than real estate investing in terms of return? 

Here, I think it’s important to share an idea from Robert T. Kiyosaki, American businessman and entrepreneur. Kiyosaki spends time outlining the unique advantages of investing in real estate, and I’ve offered a summary of those here: 

1. Real estate is an investment that someone else is going to make on your behalf. 

Since a tenant pays you rent every month, they are essentially making a deposit into your retirement account. Whereas if you work for a company, the company will have matching funds available for your retirement fund, but it will cap out at a certain percentage. Even then, you have to put in so much work before the company puts in anything. With rental property, you will make a down payment, but after that, someone else is paying 100% of your retirement contribution. 

2. Real estate is an appreciating asset. 

Typically, if you make a good buying decision, your investment will appreciate in value. For example, if you buy a $100,000 house, it’s likely to be worth $120,000 or more in five years, depending on the appreciation value of the area you buy in. 

3. Rental properties pay you to make the deal. 

If you put together the kind of deal that you should, the property will actually throw off cash and pay you to make the deal. 

So, back to the question: Can you think of something better than real estate investing in terms of return? Honestly, there’s no other investment that will accomplish what real estate investing can. Let’s say that you’re extremely risk-averse and want to minimize exposure. You may choose to invest in a municipal bond, which is a very safe investment, but it will likely only make a 3-5% growth a year. Even if that growth is tax-free, you won’t see anywhere near the returns that a rent house will give you. If you have a lot of money and don’t care about growth, a conservative bond strategy may work for you, but if you’re in the early stages of life and trying to grow your investment for retirement money, you won’t get there by investing in bonds. You’ll need to be a little more aggressive in order to grow your money. 

In Summary:

I think part of the due diligence in evaluating a risk is asking what’s on the market, what are the unique qualities of each type of investment, and is there something other than rental property that can provide a desired return. If you can think of something better to invest in than rental property, then you should by all means go do that. But I’ll leave you with a final thought: if a bank is willing to invest on your behalf, your deal can’t be that risky.