When it comes to retirement planning, it’s important to understand and assess your tolerance for risk. Risk tolerance is just what it sounds like: A measure of how much risk you can handle as an investor.
Risk tolerance depend on a variety of factors, including your financial goals at retirement; additional streams of income and/or financial assets; current and estimated future income from your job; and stability of the company for which you work. In general, you can afford to take greater risks with investable assets when you have other, more stable sources of funds available.
Additional factors that go into your risk tolerance are the amount you can afford to invest each month, your emotional ability to handle risk, and your time horizon.
Remember your risk tolerance changes over time. Age, income and life circumstances combine to form your current level of tolerance. For example, as you approach retirement, your risk tolerance could be lower since you have a shorter amount of time to rebuild if a risky investment causes problems.
Self-knowledge of your own personal financial situation is one of the most beneficial investing tools. This awareness can help accurately determine your risk tolerance and build a profitable portfolio, as well as prevent you from acting impulsively in a way that can hurt your long-term returns.
When assessing your risk tolerance, you must also realize there are equal upside and downside possibilities in your retirement investment portfolio.
During the period in which you are investing, volatility—the amount of uncertainty or risk about the size of changes in a security's value—can soar to both ends of the spectrum.
Gauging your risk tolerance can be ambiguous in many cases. Many people have the tendency to be less opposed to taking risks with investments when the market is good, in spite of the fact its not a future indicator of the health of their portfolio.
Ultimately, the only way to ride out the ups and downs of the market is knowing exactly what your risk tolerance is. That way, when you feel the market shifting, you can re-assess your situation and make sure you still feel comfortable with the amount of risk you’re taking. Work with a financial professional to help determine your risk tolerance today and you’ll be on your way to a better financial future.