How to assess your investment risk profile

A big question for any investor, especially those new to investing, is how much risk you’re comfortable with. Knowing how you feel about risk can help you choose investments that match your comfort level and build a portfolio that fits your goals.

An important first step is understanding the difference between risk tolerance and risk profile. Your risk tolerance is about your emotional comfort with market swings, while your risk profile combines that comfort with your financial ability to handle risk. You can identify your risk tolerance by walking you through a few key questions, which in turn will help you determine your risk profile. 

What is investment risk?

Investment risk is the degree of uncertainty and potential for financial loss in any investment decision. When you invest, there’s no guarantee you’ll make money. In fact, you could even lose some. Typically, as risk goes up, so does the potential for greater rewards or losses.

What are types of investment risk?

Investment risk doesn't come from just one place. The stock market, the economy, and even your own investment timeline all present potential risks.

• Inflation risk: The tendency for prices to increase over time, which means your future dollars will have less buying power.
• Interest rate risk: The risk to savings and loan rates if interest rates change. For your investments, rate increases are generally a good thing, but for borrowing, they’re not.
• Market risk: The risk of loss due to how the financial markets are performing. Stock values fluctuate daily and yearly.

However, risk isn’t always bad. To ensure your investments keep pace with inflation, you’ll likely need to take on some level of risk.

What is risk tolerance?

When it comes to investing, risk tolerance is the amount of market volatility and potential loss you’re psychologically willing to accept as an investor. It’s about your comfort level with the market’s ups and downs. Your risk tolerance is influenced by your past experiences, current financial situation, and future goals.

Key questions to determine your risk tolerance

These six questions can help you get a clearer picture of your own risk tolerance.

1. What are your investment goals?

First, ask yourself why you’re investing. Are you saving for retirement, a down payment on a house, or your children's education? Clarifying your "why" is the first step toward understanding how much risk you're willing to take on. Plus, having a goal in mind can help you assess your timeframe and estimate how much money you’ll need.

2. What's your time horizon?

Your investment time horizon is how long you plan to stay invested before you need the money.

Generally, the longer your time horizon, the more risk you can take on. For example, if you’re saving for retirement in your 20s, you have more time for your investments to recover if they lose value. While market downturns happen, and past performance is no guarantee of future results, the stock market has historically returned about 6.5% per year on average, accounting for inflation.¹

A shorter time horizon, such as saving for a down payment on a house, means your investments have less time to recover from a potential downturn. If your goal is to earn a big return in a short time, you’ll need to be comfortable with risk: If the market falls suddenly, you may not meet your goal on time.

3. How comfortable are you with short-term loss?

Investments can fluctuate in the short term. It’s important to remember that with stocks, for example, your shares may go down in value, but you don’t actually lose money until you sell the investment. If you have a longer time frame, you can hold on to an investment and hope it recovers. Can you handle a short-term loss? Your answer helps gauge your comfort level.

4. How often do you plan to check your investments?

Do you see yourself tracking your portfolio daily, or just checking in occasionally? If you track your investments often because volatility makes you nervous, you may be more risk-averse. If you're looking for buying opportunities, you might have a higher tolerance for risk. Anxious reactions to market dips suggest a more conservative strategy may fit you better.

5. Do you have non-invested savings?

It’s important to have an emergency fund in an easily accessible account, regardless of your risk tolerance. This cash reserve can cover unexpected events like a job loss without forcing you to sell investments at a bad time. However, if you keep a large amount of your savings in cash because you’re nervous about investing, it’s a strong sign that you’re risk-averse.

6. Is your portfolio diversified?

Market volatility is a given. Diversifying your portfolio ensures your investments are spread across different assets, industries, or regions. This can help reduce risk and make you more comfortable with your overall strategy.

What is a risk profile?

While risk tolerance is about your feelings, your investment risk profile is a broader measure of how willing and able you are to take on risk. It combines your risk tolerance with your risk capacity—what you can financially afford to lose.

Determining your risk profile can help you make investment decisions that you feel comfortable with and that help you make progress toward your financial goals.

Types of risk profiles

Investors generally fall into one of five risk profile categories.

• Conservative: You prioritize protecting your initial investment. You accept low risk, understanding this may limit returns and may not keep pace with inflation.
• Moderate conservative: You accept low to moderate risk and can tolerate some volatility. Your aim is a modest level of returns.
• Moderate: You accept a higher degree of risk and tolerate volatility to seek stronger returns.
• Moderate aggressive: You accept high risk and can endure high volatility to seek robust returns.
• Aggressive: You accept maximum risk and aggressively seek substantial growth and returns.

How to determine your risk profile

Your risk profile is shaped by two main things: your emotional response to market volatility (your risk tolerance) and your financial ability to handle losses (your risk capacity).

• Your risk tolerance: This is about how you feel when the market experiences a downturn. Does the thought of your portfolio losing value make you panic, or do you take an optimistic approach, knowing investing is a long-term game? The more comfortable you are with potential volatility, the higher your risk tolerance.
• Your risk capacity: This is about how much risk you can afford to take. Your time horizon is a major factor here. If you start investing for retirement in your 20s, you have decades to weather market ups and downs. If you’re closer to retirement, or saving for a short-term goal, you have less time to recover from losses and may have a lower risk capacity.

Unlock your potential

Understanding the relationship between investment risk, your personal risk tolerance, and your overall risk profile is the foundation of your investment strategy.

By honestly assessing your goals, time horizon, and feelings about market volatility, you can build a diversified portfolio that aligns with your needs. This clarity allows you to navigate market fluctuations with confidence and stay focused on your long-term objectives.

Whether you want to invest on your own or would like personalized financial guidance, there are options to meet your needs.