Investing 101: Understanding Risk Tolerance
When it comes to investing, there's a relationship between risk and reward.1 The higher the risk, the bigger the potential reward. But that relationship goes both ways. The more risk you take when you invest, the more you expose your portfolio to greater volatility and chance of loss.
When it comes to investing, you need to balance your desire for a high return with your ability to handle risk and the potential of losing money in the market.
Understanding your risk tolerance
Risk tolerance2 is your ability to handle the ups and downs that occur in the financial markets, and the potential losses that come if you need to sell when the market is down. Those with high risk tolerance are able to stand some red (loss) in their portfolios and are able to stick to an aggressive investment strategy even when the market takes a tumble. On the other hand, those with low risk tolerance hate the idea of losing even a dollar of their hard-earned cash — and aren't able to stomach seeing big losses in their nest egg.
Risk tolerance is your ability to handle the ups and downs that occur in the financial markets.
Considering risk when building your portfolio
There's no one right answer to what your risk tolerance "should" be. While you need to know what your tolerance for risk is, you also need to understand what your capacity for risk is.3
For example: you may be comfortable taking big risks, but if you're five years out from retirement, your capacity for risk might be quite low since you literally can't afford to take a big loss in the nest egg you'll need soon.
On the other hand, you could be decades away from retirement and have a large capacity to take risks, since you have lots of time to recover from losses. If you can keep your money in the market and ride out the volatility that lots of risk can bring, being more aggressive can help you build a bigger nest egg even if you feel like you can't save very much. A higher return could take the pressure off you to contribute a lot to your accounts when your cash flow is limited.
Creating an investment portfolio that merges both your goals and your ability to handle risk is important. You don't want to jeopardize achieving your financial goals.
If your risk tolerance is too high...
If you're overly aggressive when it comes to taking on risk, you could put yourself in a position where you can't recover the money you lose. You need a lot of capital and a long time horizon if you want to take big risks.
Taking on huge risks in the hopes of massive returns may not be a problem if you're young and early in your career. However, if you're approaching retirement or may want to use the money in your investment portfolio within the next five to 10 years, dial down the risk you take and consider playing it a little safer so you don't fail to miss your financial goals because you lost money in the market.
If your risk tolerance is too low...
On the other hand, you have to be careful with how safe you play it. If your risk tolerance is too low, you could miss out on the chance to build the wealth you need to retire when (and how) you want. Remember, less risk equates to less reward. And less reward in this case means lower returns — and potentially less wealth over time.
You can afford to be more conservative if you plan to start saving early — and save a lot. That takes the pressure off your investments to earn a certain return and may better align with your preference for less risk.
Trying to figure out where you stand in the risk tolerance spectrum? Try taking a risk tolerance assessment.4 Even better than an online quiz? Our professionals can help you make investment choices that reflect your appetite for risk. Call us at 1-888-SYNOVUS (1-888-796-6887.)
Important Disclosure Information
This content is general in nature and does not constitute legal, tax, accounting, financial or investment advice. You are encouraged to consult with competent legal, tax, accounting, financial or investment professionals based on your specific circumstances. We do not make any warranties as to accuracy or completeness of this information, do not endorse any third-party companies, products, or services described here, and take no liability for your use of this information.
- "Understanding Risk," Ken Little, The Balance, accessed June 4, 2018. Back
- "Assessing Your Risk Tolerance," Investor.gov, accessed June 4, 2018. Back
- "Separating Risk Tolerance From Risk Capacity – Just Because You Can Afford To Take Risk Doesn't Mean You Should," Michael Kitces, Kitces.com, accessed June 4, 2018. Back
- "Investment Risk Tolerance Assessment," Personal Financial Planning, University of Missouri, accessed June 4, 2018. Back
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