When planning for your financial future, it’s important to understand the notion of risk tolerance and to assess your own level of risk tolerance.
According to Investopedia, risk tolerance is the degree of variability in investment returns that an investor is willing to withstand. Risk tolerance is an important component in investing. You should have a realistic understanding of your ability and willingness to stomach large swings in the value of your investments; if you take on too much risk, you might panic and sell at the wrong time.
Nerdwallet notes that knowing your risk tolerance helps create a game plan, playing a key role in how you invest. If your tolerance is low, you’ll invest conservatively. For instance, a greater portion of your portfolio might be in low-risk bonds and a smaller portion in higher-risk stocks.
Here are some of the factors that go into determining one’s tolerance for risk:
- life goals – some people want to travel the world when they retire, others just want to stay put and take care of their garden
- age – generally speaking, the closer one gets to retirement, the more conservative one should get with their investments
- current savings – the more you have accumulated, generally speaking, the more risk you can take since you have a bigger cushion if the financial markets drop
- personal appetite for risk – some people love skydiving, driving in the left lane, and never visiting a doctor; others like to stay home, read, do brain teasers, and watch the news every night (wow, I never knew how apparently risk averse I am!)
If you’ve ever worked with a financial planner, one of the first things hey will ask you to do is to complete a risk profile questionnaire.
But if you’ve never dealt with a financial planner, there are free tools online to help you assess your risk profile.
I just completed one at The Motley Fool; it takes just a couple of minutes. Here are my results:
The Motley Fool survey ranks a person as either Very Defensive, Defensive, Conservative, Moderate, Moderately Aggressive, Aggressive, or Very Aggressive. As you can see, I fell into the Conservative category, which given my age, I am OK with. If I were twenty-something, I would want to be in the Aggressive to Very Aggressive categories.
I also took a survey at Vanguard, the king of mutual funds; my results there suggested a little bit more towards the aggressive side:
I took one more survey, this one at the Merrill Lynch Wealth Management. These results are right in between the above two surveys and probably most closely aligned with my personal views about risk.
Score 42 : Your risk tolerance is Moderate to Aggressive
Investors in this category are more willing to take risk, both in types of securities held and in the concentration of holdings in favored market sectors, and accept possible loss of principal. The average annual total return typically ranges from 8% to 10%, but some holdings may be aimed at higher goals. More active portfolio adjustment is a typical feature of this type of investor behavior.
Given the wealth of free tools available online, there’s no excuse for not planning for your financial future, and the first step is understanding your risk profile.
As for me, I’ve always believed in taking a long-run view with my investments, and not worry too much about the day to day fluctuations in the market. However, as I get closer to retirement, that long-run starts to look a lot shorter…
*image from Commonwealth Independent Advisor