Quick Guide to Investing: Determining Your Investment Risk Tolerance

It’s understandable to want to be cautious with your money. But interest rates have been low for the better part of a decade; and if that environment continues, you may need to take some risks in order to earn enough of a return to reach your goals. The challenge is in finding the right balance to make your investment risk reasonable rather than reckless.

bar graph - risk tolerance

How to gauge your risk tolerance

When you think about “investment risk,” what’s the first thing that comes to mind? Do you envision a huge windfall from a stock that soars? Or do you picture yourself wiped out from a market crash? Certain people, regardless of how much they have, are simply more comfortable with taking risks than others. Neither is better or worse – they’re just different.

Knowing where you fall on the spectrum between conservative (unwilling to tolerate any noticeable downside fluctuations) and aggressive (willing to take on maximum risk for maximum reward potential) is important, however, because it helps you identify how much risk you can take on comfortably without causing you to react badly when markets fluctuate dramatically.

Time and Risk

Generally, the further out your goals, the more investment risk you can afford to take:

  • Longer-term goals (e.g., retiring in 20 years, college savings for a small child)
  • Shorter-term goals (e.g., buying a house, retiring in 5 years)

Your risk tolerance may change over time

While your general feelings about risk may not change over the years, your capacity to take on additional risk may very much change based on your changing financial circumstances.

Events that may reduce your risk capacity:

  • Taking on a large mortgage
  • Having a new child
  • A job loss
  • Death of a spouse or divorce
  • Needing to care for an aging parent

Events that may increase your risk capacity:

  • Significant salary increase or bonus
  • Inheritance
  • Selling your business
  • Paying off your mortgage

DISCLAIMERS

1 “The Reality of Investment Risk,” March 6, 2015, Financial Industry Regulatory Authority

*Past performance does not guarantee future results.

 

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