Risk Tolerance

Risk tolerance has two sides. Willingness is emotional: how comfortable you feel seeing your investments fall in value. Ability is practical: how much loss your finances could actually absorb without harming your goals.

The two do not always match. A young professional with a secure job and decades until retirement may have a high ability to take risk but feel very nervous about it. A retiree who enjoys following markets may be willing to take risks but have little ability to recover from large losses.

For example, an investor who would sell everything in panic if their portfolio fell 20% has low risk tolerance. Putting them in an investment mix that can easily fall 30% in a bad year could lead them to sell at the worst time and lock in losses.

Financial advisers usually assess risk tolerance with questionnaires and conversations about goals, time horizon, income and past reactions to market falls. The result guides the choice of asset allocation. Risk tolerance can change over time, with age, wealth, experience and life events, so it is worth reviewing periodically.