What is my risk tolerance?
Risk tolerance refers to the amount of loss an investor is prepared to take on when making an investment decision. Everyone has a different level of risk tolerance based on their personal financial situation and stage of life. Understanding your risk tolerance is a crucial step in determining the appropriate allocation of your investment portfolio.
What to consider when determining my risk tolerance?
Your goals:
Your financial goals determine the amount of money you will need in the future. It is important to understand the financial requirements of your goals relative to your current investments and financial situation. In doing so, you can develop an investment strategy with an appropriate level of risk to achieve the returns necessary to meet those goals.
Your timeline:
Markets are unpredictable, so individuals with short-term financial goals may not be able to ride out the ups and downs. Less risky investment options may be better for their goals. For example, someone planning to buy a house in the next few years would likely require a more risk-averse portfolio. This is different than someone saving for a long-term goal like a child’s college education.
Your capacity for loss:
Your capacity for loss is essential in determining your risk tolerance and in ensuring your investment strategy aligns with your goals and ability to withstand fluctuating markets. It refers to how much you can afford to lose without jeopardizing your financial stability. For example, someone with a $1 million portfolio can generally afford to take more risks than someone with $200,000. Your financial responsibilities and overall financial health also affect your capacity for loss.
Your personal comfort level:
Everyone is different, and some people are naturally more comfortable taking risks than others. Those who are most stressed by market volatility often require more conservative portfolios.
Conclusion:
Planned Ahead assesses the risk tolerance of all clients when they begin to work with our firm. Following the assessment, we use our conversations with you and your financial plan to update your tolerance level and work with you on an investment strategy. Life-changing events can impact one or more of the factors that affect your risk tolerance, which is why it is critical to keep an open line of communication with your advisor. These events may include a new child, marriage, change in income, new home, and more.
Questions? Please contact us or reach out to your advisor.
Updated: June 24, 2024
Written: June 15, 2021