How to determine risk tolerance

Investing insights

Building your investment strategy requires careful planning. It starts by identifying the specific financial goals you wish to achieve and the amount of time you have to make those goals a reality. Another critical aspect is determining the amount of risk you’re comfortable with – or what’s referred to as your risk tolerance level.

Risk tolerance is the amount of market volatility and loss you’re willing to accept as an investor. Determining risk tolerance isn’t always easy, and it requires some thought and reflection on your part. There are two key factors that can help you assess where you fall on the risk tolerance scale.

What is your time horizon?

The first factor in determining your risk tolerance level is your investment time horizon, or the time you have left to reach your financial goals. While markets occasionally suffer significant down periods, they’ve historically rebounded over time. So, the younger you are, the more time you have to ride out market volatility. By contrast, if you’re closer to reaching specific goals, such as retirement, you may be more sensitive to short-term swings in the markets and the effect on your investment portfolio.

How do you feel when the market is volatile?

The second factor is your emotional response to market volatility. Consider how you would honestly react to different market scenarios. For example, when markets decline, it means you will, at least temporarily, experience a loss in the value of your investments. If you’re comfortable with that risk, you likely fall on the higher end of the risk tolerance scale. However, if market setbacks are unsettling for you, you may fall on the lower end of the risk tolerance scale.

Knowing your risk tolerance level is critical in helping you develop your investment strategy. Your financial objectives, your time horizon and your emotional response to market volatility can guide how you want to put your money to work over the long term to help you meet your most important goals.

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