What are you willing to lose? Risk tolerance can be applied to many parts of our lives. But one part that hits home is our financial well-being. How much are you willing to risk for a gain? This can be a complicated question to answer.
Assessing Your Risk Tolerance
To assess your risk tolerance, you need to propose hypothetical challenges and worst-case scenarios.This is the question that everyone should ask themselves: If your portfolio lost 20 percent in one year, what would you do?
In this scenario, could you sleep at night? You might be the sort of person who pulls out your remaining funds and goes with a low-risk product.
Or, are you the kind of person who would put more money into the stocks to take advantage of the discounted prices?
And then, there’s the person who sits tight with the investment, waiting for the inevitable market correction.
Factors That Determine Risk Tolerance
Typically, the longer you can wait to tap into your funds, the higher your risk can be. Therefore, age can often play a role in where one falls on the risk tolerance spectrum. But other factors come into play as well.How Soon You Will Need the Assets
Those in their 20s can generally wait longer to access their assets or yield returns than those in their 50s. A 25-year-old can afford to take risks because they have the time to make up any losses.This isn’t true for 55-year-olds; they’re staring down the road toward retirement. So, this individual likely will be more cautious with investing.
Type of Salary Earned
How someone earns their income is a big factor when determining risk tolerance. People who have steady incomes and earn the same amount every month will often be more comfortable with risk. They know exactly what they’re going to earn and how soon they can make up a possible loss.Individuals who work on commission and don’t know their income from month to month may be less comfortable with risk. They may not be sure that they can make up a loss or even survive it. This may also be true for those who run their own businesses and have fluctuating revenues and profits.
Family Obligations
Young couples with children often go into saving mode. Any extra money they can find usually goes toward saving for education or a house. They tend to have a low risk tolerance.Those without children may be helping an aged parent, so funds may be tight.
Spouse’s Desires
Just because two people are married doesn’t mean they have the same risk tolerance. In fact, they may have opposite views of risk. When this happens, a balanced approach is advisable.Liquidity Needs
Your looming cash needs will play a role in determining your risk tolerance. The closer that need for cash comes, the less risk tolerance you'll have. If you have a significant expense coming up, the thought of losing your money could cause some sleepless nights.Investment Experience and Risk Tolerance
What is your experience with investing? You can’t determine your risk tolerance without knowing about investments.It’s easy to open an online brokerage account and pick stocks. But what do you know about it? Going online for advice could backfire and lead to losses.
Risk Could Shape Investment Decisions
Not wanting to take risks is normal, especially if doing so keeps you up at night. But keep in mind that a total lack of risk may impede you from reaching your overall goals.If you’re decades away from retiring and don’t assume any risk, you could fall short. This is especially true if you factor in inflation.
When looking to reach goals, you may want to pursue strategies that have the potential to beat inflation.
On the other hand, an aggressive investor who is about to retire may want to scale back. This is particularly true if your portfolio is all stocks. You don’t have as much time to recover from a large downturn.
Your risk tolerance changes over time as your goals change. That’s why it’s important to review your portfolio often.
Consider contacting a financial adviser to help you assess your risk and determine the best course of action for your situation.
