What Is Risk Tolerance?

Risk tolerance refers to the amount of financial risk you’re comfortable taking when investing. Market volatility is unavoidable, and investment values are constantly in flux due to factors like political news, economic strength, global crises, industry disruptions, and earnings reports. Your risk tolerance describes how much investment risk you can reasonably stomach, which can vary from one investor to the next.

Why Is It Important to Understand Your Risk Tolerance Before Investing?

Understanding your risk tolerance is crucial for creating a portfolio that feels right for you. It helps in selecting investments and building an asset allocation that reflects your appetite for risk. For instance, a high-risk investor might invest heavily in startups or cryptocurrency, while a conservative investor might prefer bonds and real estate.

Your age and financial goals also impact your investment strategy. Younger investors may be more comfortable with risk, while those nearing retirement might prefer safer investments.

Types of Risk Tolerance

Risk tolerance exists on a spectrum, and it can evolve over time. Here are the three most common types:

Aggressive Risk Tolerance

Investors with aggressive risk tolerance don’t shy away from volatile assets like individual stocks, private equity, hedge funds, cryptocurrency, and real estate. While these investments could yield high returns, they also come with the risk of significant losses.

Medium Risk Tolerance

Medium risk tolerance investors prefer a balanced mix of assets to spread out risk. A common strategy is the 60/40 portfolio, which holds 60% stocks and 40% bonds. This diversification helps offset losses in one area with gains in another.

Low Risk Tolerance

Low risk tolerance investors prefer safer investments to avoid significant losses. However, it’s important to maintain some exposure to the stock market to combat inflation. A 50/50 portfolio of stocks and bonds is a common choice for conservative investors.

How to Determine Your Risk Tolerance

A financial advisor can help you determine your risk tolerance. You can also ask yourself the following questions:

• How many years do you have until retirement? A longer time horizon may allow for more risk.
• What are you investing for? Specific goals like buying a home or starting a business may require different risk levels.
• How do you feel about risk? Your personality and comfort with uncertainty play a big role in your risk tolerance.

The Bottom Line

Every investor is different. Some are comfortable with high-risk investments, while others prefer a more conservative approach. Regardless of where you fall on the spectrum, you can create an investment portfolio that aligns with your risk tolerance.

Investing is just one part of financial wellness. Managing debt and maintaining healthy credit are equally important. For any mortgage service needs, call O1ne Mortgage at 213-732-3074. Our team of experts is here to help you navigate your financial journey.