Any experienced investor or financial advisor will tell you that the stock market will fluctuate. There are no guarantees, but time-tested investment principles show favorable results for those who remain focused on their goals. However, it is not uncommon for market performance during downturns to have a major impact on your financial and mental well-being.
Understanding how comfortable you are with the risk of your investments will not only help you determine your investment strategy and plan, but will also help you determine how comfortable you are with the opportunity to take a loss.
What is Risk Tolerance?
It is common to see trading tips or recommendations broken down into different levels of risk tolerance, but risk tolerance is not often defined for individuals. Risk tolerance, also known as risk comfort, is an individual’s willingness and ability to take risks that could lead to losses in investing. A risk profile is an analysis of a person’s risk tolerance that is used to create and complete a risk tolerance investment plan.
Accurately identifying your risk appetite can be tricky. If you’re someone who likes to take risks, but approaching retirement age, a high-risk portfolio probably isn’t the option for you.
Align Your Goals
Risk tolerance is often divided by age. Younger people have a longer time horizon to take risks when investing. A time horizon is the period during which a person can hold an investment before wanting to use their investment income.
Your investment goals should be based on both your financial ability to invest and your willingness to take risks in the market. Risk is not something that needs to be changed annually, but something that needs to be monitored and adjusted based on various milestones or events in one’s life, such as retirement.
For example, moving from an asset accumulation goal to an asset distribution mindset will often hinder your ability to handle volatility.
By aligning your risk with your asset allocation, you can protect your investments against losses in times of volatility, ensure that your investments are still on track and prevent spontaneous reactions to market dips.
The risk profile is determined by various factors. The key indicators of an individual’s risk profile are response to volatility, behavioral finance, cash flow analysisand the desired level of risk comfort.
- Reaction to volatility in the market is the level of losses you can withstand without reacting to a trade.
- Behavioral finance refers to how you view and make other financial decisions in your daily life.
- Cash flow analysis is the breakdown of your income and your expenses, usually broken down into quarters, months or years.
- Desired risk comfort level is the level of risk that your investments and assets allocate appropriately.
Investing without the help of an expert can be difficult. Gauging your own risk level and how you translate that into an investment portfolio is helped by examining your financial advice.
At Fragasso Financial Advisers, wealth management Pittsburgh, determining our client’s risk profile is a critical step in creating a successful portfolio. They recently published a blog post on Risk Comfort that goes into more detail on this topic.
Investment advice is provided by Investment advisor representatives through Fragasso Financial Advisors, a registered investment advisor