What Is Your Level of Investing Risk Tolerance?
The risk vs. reward equation applies to many things in life. The more risk you’re willing to assume, the higher your possible reward — and your potential loss.
Frontier knows that gauging risk vs. reward is critical to formulating your investing strategy. It starts with determining your level of risk tolerance. In other words, how much investing risk are you willing to take in order to try to realize a certain level of return on your investments.
Low vs. High Tolerance
If your risk tolerance level is low, then you might be better off choosing safer investments that are less volatile and less like to fall dramatically in value. On the flip side, if your risk tolerance level is high, then you might be comfortable choosing investments with higher volatility that can rise or fall dramatically in value.
We believe that a risk tolerance questionnaire can be helpful in gauging your level of risk. Many financial advisors ask clients to complete this questionnaire to help them choose the most appropriate investments for their clients.
However, completing a risk tolerance questionnaire is just the first and most basic step in gauging your risk tolerance. These questionnaires tend to be fairly broad and general in nature, and don’t necessarily do a good job of digging deep into the nuances of your personal risk tolerance level.
3 Questions to Ask Yourself
Based on our experiences, there are three main questions you should ask yourself as you gauge your level of investing risk tolerance:
- When will I need the money I’ve invested? Generally speaking, the longer your investing time horizon, the more risk you can assume with your investments. This is because you’ll have more time to recover any losses that might occur due to short-term drops in the market.
For example, your investing goal might be to save money for retirement. However, if you’re in your 20s, you’ve got 30 to 40 years or longer until you will need the money, so you can probably afford to assume more risk. But if you’re in your 50s or 60s, your time horizon is much shorter and your risk tolerance level might need to be lower.
- How prepared am I emotionally to handle high levels of market volatility? This is sometimes referred to as the “what keeps you awake at night?” test.
If you’re the kind of person who lays awake at night worrying about your investments losing money, then you probably have a low risk tolerance level. But if you can ride out market highs and lows emotionally and not feel compelled to make buy and sell decisions based on short-term market fluctuations, then you probably have a higher risk tolerance level.
- What assets do I possess other than those in my investment account? Again, consider investing for retirement. If you have a pension plan, an inheritance or other savings outside of your retirement plan, then you might be able to assume more risk with the investments in your retirement portfolio.
Risk tolerance is a very personal thing — everyone’s risk tolerance level is a little bit different based on what we, at Frontier, have experienced. If your risk tolerance is low, but it seems like all of your friends are “wheelers and dealers” with high risk tolerance, you shouldn’t let this influence your investing decisions. After all, you’re the one who has to sleep at night.
Please contact us if you have more questions about determining your level of risk tolerance. We can walk through a risk tolerance questionnaire with you, as well as discuss these three questions to help you determine your own personal risk tolerance level.