Assessing Your Financial Risk Tolerance
Risk tolerance is the ability to withstand losses in your investments when they perform poorly, and is determined by a combination of factors such as your investment goals and experience, how much time you have to invest, and other financial resources. If your tolerance is low, you’ll invest more conservatively, such as having a bigger portion of your portfolio in low-risk bonds, and a smaller portion in high-risk stocks. Everyone’s risk tolerance is different, so knowing yours can help you create a game plan.
In order to gauge your risk tolerance, a financial planner can help you assess where you stand by asking some of the following questions:
- How varied do you want your portfolio to be?
- What kind of investments might keep you awake at night?
- How much money are you willing to lose?
- Are you more concerned about losing money or losing purchasing power?
- How worried do you think you would be in a severe market decline?
Risk Tolerance Factors
Once you determine your level of risk tolerance, you can start determining the factors that form your portfolio. It’s important to remember that these factors and your risk tolerance will change overtime, based on where you are in life and what type of investments you’re likely to make.
Goals: Financial planning is a guide to deciding what you want out of life, and calculating how much money you need to reach your goals. Once you determine your goals, you can choose an investment strategy that will deliver the appropriate returns.
Timeline: Assessing your goals is going to help you better understand the timeline of your investments. Fluctuation of the stock market is inevitable, and there are always going to be dips and plateaus. Generally, you can take more risks if you have more time to ride out the bumps. So if you’re in your 30’s and saving to retire at 65, you have plenty of time to recover from those dips, but if you’re saving to buy a house in a few years, investing in high-risk stocks might hurt you as there likely won’t be enough time to recoup losses if the stock market drops.
Ignoring Risk Tolerance
Investing without considering your risk tolerance can leave you and your money in a vulnerable position. Investing in high-risk stocks without knowing how or when they could drop leaves you unprepared for how to handle that change in your money, and may lead you to act out of emotion. A big danger of being unprepared for when the market drops is fleeing and selling low, you’ll lose everything you invested instead of waiting out for recovery.
Another danger is not taking enough risk to reach your goals. You’ll have a harder time achieving the most of your investments, whereas taking a slightly more aggressive position to get better returns can make a huge difference in the long run.
Take Risk Tolerance Seriously
As mentioned above, ignoring your risk tolerance isn’t the best way to maximize your investments. Taking the time to understand risk can help you avoid being caught off guard when values drop. The stock market is very volatile, and taking risk seriously can help you mentally prepare for when things get bumpy. Having a plan and sticking to it can help you avoid mistakes and impulsive decisions with your investments.
People come to us with varying perceptions regarding their investment needs. We help clients focus on what’s most important through our comprehensive planning approach. The end result can often shift a client’s view of how they would like to focus their investments, which tells us how important this comprehensive approach really is! We take pride in offering a comprehensive life and financial planning process to anyone regardless of their level of wealth, because we are passionate about making a lifelong difference.
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