How to Assess Your Investment Risk Tolerance
Today, we explain what investment risk tolerance is, how to determine yours, and why it matters for your investment strategy.
How to Assess Your Investment Risk Tolerance
Investing in stocks and shares can be a rewarding way to grow your money over time, but it also involves some risks. How much risk are you willing to take with your money? And how does that affect your investment strategy? These are important questions to ask yourself before you start investing, as they can help you choose the right investments for your goals and preferences. Today, we will explain what investment risk tolerance is, how to determine yours, and why it matters for your investment strategy.
What is investment risk tolerance?
Investment risk tolerance is a measure of how comfortable you are with the possibility of losing money on your investments. It reflects your attitude and perception towards the uncertainties and fluctuations associated with investing. A risk-averse investor prefers more certainty and stability in their portfolio returns, while a risk-tolerant investor is willing to accept more volatility and variability in exchange for potentially higher returns.
Investment risk tolerance is not a fixed or static trait. It can change over time depending on your personal circumstances, goals, and experiences. For example, you may become more risk-averse as you get older or closer to retirement, or more risk-tolerant after a positive experience with a risky investment.
How to determine your investment risk tolerance?
There is no one-size-fits-all way to determine your investment risk tolerance. However, there are some factors that can help you assess it, such as:
Your financial situation: This includes your income, expenses, assets, liabilities, savings, and emergency fund. You should have a clear picture of your current and future financial needs and obligations, and how much money you can afford to lose or lock away in investments. Generally, the more financially secure you are, the more risk you can take.
Your investment goals: This includes your reasons for investing, your time horizon, and your expected returns. You should have realistic and specific goals for your investments, and know how much money you need to achieve them and when. Generally, the longer your time horizon and the higher your expected returns, the more risk you can take.
Your personality: This includes your emotions, preferences, values, and beliefs. You should be aware of how you react to stress, uncertainty, and losses, and what motivates you to invest. Generally, the more confident and optimistic you are, the more risk you can take.
One way to determine your investment risk tolerance is to use a questionnaire or a tool that asks you a series of questions about these factors and gives you a score or a category based on your answers. For example, you can try this free risk attitude checker from Fidelity International or this risk questionnaire from Standard Life. These tools can give you an indication of your investment risk tolerance level, but they are not definitive or comprehensive. You should also use your own judgement and common sense when evaluating your risk tolerance.
Why does investment risk tolerance matter for your investment strategy?
Your investment risk tolerance matters for your investment strategy because it helps you choose the right investments for your portfolio. Different investments have different levels of risk and return potential. For example, cash ISAs are low-risk but also low-return investments, while stocks and shares ISAs are high-risk but also high-return investments.
Your investment strategy should match your investment risk tolerance level. This means that you should choose investments that suit your comfort level with risk and volatility, as well as your financial situation and goals. For example, if you are very risk-averse, you may want to invest mostly in cash ISAs or bonds that offer stable and guaranteed returns. If you are very risk-tolerant, you may want to invest mostly in stocks and shares ISAs or funds that offer higher but variable returns.
By choosing investments that match your investment risk tolerance level, you can achieve several benefits:
You can maximise your returns for the level of risk you are willing to take.
You can avoid investing in products that are too risky or too conservative for you.
You can reduce the stress and anxiety associated with investing.
You can stick to your investment plan and avoid making impulsive or emotional decisions.
Investment risk tolerance is a measure of how comfortable you are with the possibility of losing money on your investments. It reflects your attitude and perception towards the uncertainties and fluctuations associated with investing. To determine your investment risk tolerance level, you should consider factors such as your financial situation, your investment goals, and your personality. You can also use questionnaires or tools that can help you assess it. Your investment risk tolerance matters for your investment strategy because it helps you choose the right investments for your portfolio that suit your comfort level with risk and volatility, as well as your financial situation and goals. By doing so, you can maximise your returns, avoid unnecessary risks or losses, reduce stress and anxiety, and stick to your investment plan.