Risk tolerance can be described in several ways, but it often comes down to this question: How much of a decline in the value of your investments are you comfortable accepting in exchange for higher potential returns over the longer term?
For most people, risk tolerance doesn’t change—at least not until retirement nears. However, certain factors can make some individuals become less or more tolerant to investment volatility.
Reactions to the market cycle
Some experienced investors who have lived through multiple market cycles can find their risk tolerance changing. A conservative investor could be open to holding more equities in their portfolio, reassured that past market declines were all followed by recoveries. On the other side of the coin, a growth-oriented investor could become less tolerant to risk. When they were just starting to save, they may have tolerated a 20% decline in their portfolio value, but now it may not be so easy to accept the dollar value of a 20% drop in a large portfolio balance.
Changes in your financial situation
Tolerance to risk can increase or decrease following a significant change in someone’s financial situation. For example, a recently divorced individual may re-examine their portfolio after considering the costs of a divorce settlement and child support. Fulfilling their new financial responsibilities could make this person less tolerant of investment risk.
Shortened time horizon
Someone’s investment time horizon—the number of years until they need to access their funds—also affects risk tolerance. When retirement approaches, an investor typically reduces their portfolio’s risk level. No one wants to risk a market collapse, jeopardizing a happily anticipated retirement date.
If your tolerance to investment risk ever changes, please talk to us. We’ll make sure your portfolio aligns with the change and you remain on track to meet your financial goals.