All investments come with risk. Generally, the higher the potential return an investmentInvestment An item of value you buy to get income or to grow in value.+ read full definition might offer, the higher the risk. When you take on greater investment risk, there is no guarantee that you will actually get a higher return.
Your risk tolerance considers your ability and willingness to make an investment and accept the outcome, even if it doesn’t produce the expected results.
Over time, your risk tolerance may shift as your financial circumstances change and your personal needs evolve. For example, life events like getting married, having a child, or preparing for retirement can make you rethink your risk tolerance and overall investment goals.
Here are three things that could make you reassess your risk tolerance:
1. Time horizon
In general, the longer your investing time frame, the more risk you can afford because you have more time to recover if an investment doesn’t perform as expected. When you land your first full-time job and start saving for retirement, you may be able to accept more risk because you won’t need to access the money for decades. While a riskier strategy can mean greater volatilityVolatility The rate at which the price of a security increases or decreases for a given set of returns. A stock price that changes quickly and by a lot is more volatile. Volatility can be measured using standard deviation and beta.+ read full definition, over time, you may benefitBenefit Money, goods, or services that you get from your workplace or from a government program such as the Canada Pension Plan.+ read full definition from stronger returns.
While taking on more risk may be appropriate under some circumstances, it may not be a prudent approach for all your savings. No matter how comfortable you are with risk, if you expect to need the money within the next few years, perhaps to buy a house or go on a vacation, consider adopting a more conservative strategy.
2. Life changes
- When do you expect you will need that money?
- Do you have any big purchases you’re saving up for (e.g., a car or a house)?
- How would you respond if the value of your portfolioPortfolio All the different investments that an individual or organization holds. May include stocks, bonds and mutual funds.+ read full definition dropped 20%?
- What is the level of your investment knowledge?
Over time, your risk tolerance will fluctuate depending on changes in your life. The loss of a job, starting a business, the birth of a child or receiving an inheritanceInheritance Property, money, titles, or debts that pass to you after someone’s death.+ read full definition are just a few factors that may influence how much risk you may be willing to accept. Some of these events might be planned, but not all of them. An emergency can be another factor that suddenly changes your financial circumstances and risk profile.
Be sure to revisit your decisions around risk periodically. Even if you’re working with an advisor, it’s still up to you to inform them about changes in your life that may affect your risk tolerance. If you’re managing your portfolio on your own, assess your portfolio every year to make sure you’re still comfortable with the risks you’re taking.
3. Personal preference
Being asked if you’re comfortable with risk and volatility in your portfolio is very different than experiencing it firsthand. A strong emotional response to a sudden loss can influence your investment decisions. Although managing emotions can be challenging, it’s another factor to accountAccount An agreement you make with a financial institution to handle your money. You can set up an account for depositing and withdrawing, earning interest, borrowing, investing, etc.+ read full definition for because emotionally driven decisions can harm your portfolio.
Two people in the same situation may have very different risk tolerances. It’s important to have a portfolio that matches your goals and appetite for risk. Ideally, you want to adopt a strategy that you can be comfortable with over the long termTerm The period of time that a contract covers. Also, the period of time that an investment pays a set rate of interest.+ read full definition.