Risk Tolerance: What Is It And Why Is It Important?
Most decisions you’ll make in life involve taking risks, whether it’s starting a new relationship, purchasing a home, or deciding to invest your money. When you decide to take a risk, you’re deciding not how much risk it’s going to be, but how much risk you are personally willing to take. This idea is called risk tolerance, and it’s important to consider when making risk-based decisions, particularly when investing.
What is Risk Tolerance?
Risk tolerance in the investment industry is the variability in returns that an investor is willing to stomach in their financial planning. It gives an investor a realistic understanding of gains and losses in their investments.
When it comes to investing, the phrase “no pain, no gain” sums up the relationship, and risk and reward go hand in hand. Most investments won’t always trend upwards, so it’s important to determine the amount of risk you are personally willing to take. When evaluating your personal risk tolerance, think about how you will be able to handle a large decline in your investments.
Why is Risk Tolerance Important?
Risk tolerance can play a crucial role in your plan for growing your money without the stress of a huge loss. If you don’t think you can handle a large loss, it may be a sign to stick with smaller risk investments for the time being.
On the other hand, if you find that you are okay with large potential losses, it could be a sign that you’re ready to take on a larger risk investment. Risk tolerance often relates to your position in life, your age, and the amount you can afford to lose financially. If you are in your 20’s and deciding how to invest your 401k, you are probably in the position to have a higher risk tolerance. However, if you are close to retirement, you may want to lower your risk tolerance.
Regardless of your age, your personal risk tolerance is important to find before deciding what and where to invest.
How to Find Your Risk Tolerance
It’s easy to say you have a high risk tolerance when the market and your investments are successful, but your true risk tolerance will come when the market is failing.
For example, the Covid-19 pandemic practically crashed the market in March 2020. How were you feeling about your investments during that time? Did you sell your stocks in panic, or did you take advantage of the market sell-off and investment more?
If your risk tolerance truly is high, you chose to invest additional funds and it could have served you well since the market was setting record-breaking numbers in late 2021.
However, this is not always the case, and a high risk tolerance can also lead to huge losses in the market. Try taking an online quiz or questionnaire to determine your risk tolerance.
Types of Risk Tolerance
High Risk Tolerance
Those with the highest risk tolerance are considered to be aggressive. These investors are typically market-savvy and have a deep understanding of the investment market. Those with aggressive risk tolerance tend to reach for high risk and high reward.
Moderate Risk Tolerance
Moderate risk tolerant investors accept a smaller amount of risk with a more balanced approach to investing. These investors focus on diversifying their portfolio and investing in both high risk high reward investments and less volatile bonds and securities.
Low Risk Tolerance
Those with a conservative risk tolerance are not willing to accept any risk in their investments. These investors target opportunities that are guaranteed, such as U.S. Treasuries.
Call Carty & Co.
If you need more information regarding risk tolerance, or alternative suggestions on finding your personal risk tolerance, contact an experienced financial professional at Carty & Co. Be prepared to discuss your financial situation, and what you hope to accomplish with your investment.
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