What is risk tolerance? Risk tolerance measures the degree of variability in investment returns that investors are willing to withstand during financial planning. It’s a vital part of investing; when you’re investing your money somewhere, you should have a realistic understanding of how you’ll handle swings in the value of your investments. If you risk too much, you could sell at the wrong time and make the investment for naught.
How does an investor figure out what they’re able to risk when planning? Here are some key factors to keep in mind when assessing your risk tolerance.
Investment Time Frame
The younger you are when you start investing, the longer you have to take risks, while elderly investors will likely have low investment risk tolerance. Even following that general logic, it wouldn’t do well to take this at face value. Every situation has its own unique set of circumstances: when will the capital be needed? What does your time horizon look like? If it’s short, you should take more conservative risks. Meanwhile, long-term investments allow you room to be more aggressive with your investments. Everything in life plays a factor in your investments that you must consider.
Risk capital, or liquid capital, is money you have to invest or trade that won’t affect your lifestyle if lost. This should play a large role in figuring out your risk tolerance; how much are you willing to lose? How much are you able to lose without risking your lifestyle? Investors with a high net worth can risk much more than someone with a low net worth. The smaller your investment is for your net worth, the more aggressive your risk tolerance can be.
Are you new at investing? Have you been doing this for years? When you’re figuring out your risk tolerance, this should be at the forefront of your mind as well. Whenever you begin something new, it will do you well to begin cautiously, even outside the investment world, so apply that caution here if you’re just starting out. Once you have investment experience under your belt, you can begin to be a bit more aggressive.