What is risk tolerance?
Critical to your success as an investor is understanding what is known as your personal risk tolerance or risk profile and ensuring you invest within your limits using suitable investments aligned to the risk you are comfortable taking.
Risk tolerance is a measure of your ability and willingness to take risks with your money, with the understanding that the performance of your investments may not align with the expected results. Many investors aim to achieve the highest possible return with their investment portfolio with suitable risk-aligned investments.
Understanding how much risk you can take with your money
When considering your ability to tolerate risk, reviewing your financial health is important. Assessing your savings, other investments, when you need to use the money, and your ability to earn income to offset investment losses and maintain your standard of living can help you better understand how much risk is suitable for you.
Understanding how much risk you are comfortable taking with your money
The other component comprising your risk tolerance is your comfort level or psychological risk tolerance. Investing can be emotional, with investors feeling stressed, scared, anxious and uncomfortable with investments carrying unsuitable levels of risk. Before putting money towards any investment, review your level of risk and contemplate how you would react to a significant loss.
Investing within your risk tolerance
Whether investing on your own or working with a financial advisor or robo-advisor, a risk tolerance assessment is an essential first step.
Financial advisor
When working with a financial advisor, they are required to understand your financial health, investment objectives, investment knowledge, and risk tolerance by going through a process called Know Your Client (KYC). This ensures they can recommend suitable investments that align with your risk tolerance.
Robo-advisor
When opening an investing account with a robo-advisor, investors are presented with mandatory screening questions similar to the KYC process. This gives the robo-advisor an understanding of your overall risk tolerance, financial circumstances and investment goals before assigning a suitable portfolio that meets your objectives.
Self-directed investing
Investing on your own requires you to take the time to assess your personal risk tolerance before starting. If you would like to understand your risk tolerance better, try the free risk tolerance quiz from CheckFirst.
Be honest with your responses when filling out any KYC or risk tolerance form. By accurately filling out the forms, you are more likely to make suitable investments for yourself.