How do I determine my risk tolerance?

During the pandemic, many people had an eye-opening experience regarding their investment risk tolerance. 

In ways big and small, we all have had to calibrate our own comfort level with the risks posed by COVID-19–including those tied to our investment portfolios and the stock market.   

With that in mind, here are some steps you can take to understand your unique risk tolerance and ideal portfolio risk level.  

Risk Tolerance and Uncertainty 

Risk is a two-way street–it can spell opportunity and potentially lead to increased gains, but it can also lead to increased losses. Your willingness to tolerate these potential losses and large market swings is your risk tolerance.  

One determinant of your risk tolerance is your comfort with uncertainty. Are you the type of person that needs to have a plan for every aspect of your life? Or do you enjoy life’s unknowns? How does the possibility of financial loss make you feel? Determine your “do not lose my money” factor. 

Sometimes it can be hard to know your comfort level with financial risk. You may be able to measure this in part by considering your reaction in March 2020. The market exhibited extreme levels of volatility at that time. Think back to your response to this high level of uncertainty: 

  • Did you begin to sell your investments during the decline? Did you want to liquidate stocks? If you are in this camp, you may have a more conservative risk tolerance 
  • At the other end of the spectrum, were you eyeballing the uncertainty as a potential opportunity? Were you looking to buy? If that’s you, you may have a more aggressive risk tolerance 

If you find yourself somewhere in the middle of these two extremes, you may have a moderate risk tolerance. 

Everyone has a high tolerance for gains. Declining investment values like we saw in March 2020 are the true litmus test–and where the rubber meets the road for risk tolerance.  

Determining Your Portfolio’s Level of Risk 

Though your comfort with risk is important, it shouldn’t be the only factor in determining the level of risk in your portfolio. Other factors we should consider include: 

  1. Your Investment Objectives: Is your objective to grow a retirement nest egg, or rather to preserve already accumulated capital? Is a stream of income from your holdings a priority? Is your retirement already funded, and do you enjoy speculating in the markets?  
  1. Your Investment Time Horizon:  If you need the money sooner rather than later, for example, your risk tolerance should be lower. If you are in your twenties and have 40-plus years until retirement, your risk tolerance should be higher.  

These factors and others, including income (current and anticipated future income), age, and an individual’s risk capacity, can all be helpful in determining the type of risk you are willing and able to take at the moment. If you’re interested, our team of financial advisors can help you assess your current risk tolerance and capacity and adjust your investments as needed.  

Feel free to reach out if you would like to do so or if we can be of assistance with any other financial matters.  

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