Reviewed by Sep 28, 2020| Updated on
Introduction to Risk Tolerance
The investment term "risk tolerance" refers to the amount of market risk that an investor can bear, such as uncertainty or market ups and downs. Financial planners often utilise risk tolerance to categorize investors and their investing patterns such as moderate, conservative, or aggressive.
Measuring and assessing your risk tolerance needs to be your first step when it comes to selecting the best investments for your financial objectives. When you know how much market risk you can handle, you can pick the correct investment that matches your risk profile.
Why is Risk Tolerance Important?
Until selecting their investments, it is crucial for each investor to determine their risk tolerance. Knowing your risk tolerance, you'll get a better idea of which forms of investment are ideal for you and which investments you can avoid.
How to Measure Your Risk Tolerance?
The financial planner may give you a questionnaire on risk tolerance which will ask some questions about different market scenarios. You will predict the reaction to the given market scenario and answer the questions accordingly.
Disowning an investment strategy all of a sudden because of adverse stock market behavior does not serve the interests of an investor, particularly in the long run. The risk-tolerance questionnaire will assist the investor by choosing the right investment mix to predict and avoid poor investment conduct.
Risk Tolerance Versus Risk Capacity
Risk tolerance comprises a feature which is called “risk capacity”. It determines the amount of risk you can afford to take. This is different from your willingness to take the chance. In other words, you may be happy with an aggressive, high-risk portfolio but if you have just a few years to reach your investment target, such as retirement, a portfolio of 100 percent stocks may not be acceptable.
In this situation, you may be better served with a portfolio that is more conservative or less volatile to protect the investment assets you will need to retire.
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