What is risk tolerance?
All investors have a risk tolerance of varying degree. Your risk tolerance refers to your ability and willingness to withstand fluctuations in the value of your portfolio.
Your risk tolerance is determined by a multitude of factors, such as:
- Short-term and immediate financial needs
- Longer-term financial goals
- Investment time horizon
- Income and cash flow
- Investing experience
- Personal attitudes regarding risk and reactions to market volatility
Typically, the longer your investment time horizon, the more risk you can handle. That’s because your portfolio has more time to recover from losses.
Likewise, a greater income and investing experience comes with a greater tolerance for risk. If, however, you have an immediate need to cover major expenses like a home mortgage or college tuition, you may not be willing to risk as much.
Everyone’s risk tolerance is different and informs the way they invest. Investors generally fall into three key categories regarding risk tolerance:
- Conservative investors tend to have a lower risk tolerance and, therefore, prefer capital preservation over aggressive growth. They typically invest in lower-risk, stable assets.
- Moderate investors are likely to be more willing to accept some risk for potential returns, so they seek a balance between the preservation and appreciation of capital. They may allocate their portfolios across a mix of asset classes.
Aggressive investors are more often willing to accept high levels of risk for potentially high returns. They prioritize capital appreciation by primarily investing in growth-oriented assets, including those associated with high volatility.
