Knowing your risk tolerance level is a critical component in building your investment strategy. Your investment time horizon and your emotional response to market fluctuations are two of the key factors to consider when assessing your risk profile.
Your risk profile refers to how willing and able you are to take on risk while investing—and it should be a major consideration when you’re forming your investment strategy. Determining your risk profile can help you make investment decisions you both feel comfortable with and that help you make progress toward your financial goals.
Let’s explore how to determine your risk profile to make the best financial decisions for your future.
Like many things, risk tolerance is a spectrum, with some investors on the conservative end and others on the very aggressive end. If you’re wondering how to assess your risk profile, start by asking some important questions about your investment goals, preferences, and habits.
After answering these preliminary questions, consider two of the biggest factors that will help determine your risk profile: your investment time horizon and your emotional response to market volatility.
One of the biggest factors in determining your risk profile is your investment time horizon, or the time you have left in working toward your financial goals.
Consider the investment goals you identified above and ask yourself how much time you have to achieve them. If you start investing for retirement in your 20s, you’ll have plenty of time to weather the inevitable ups and downs of the market. If you’re closer to retirement age—or if your financial goal has a shorter time horizon, like saving for a down payment on a house—you may be more sensitive to short-term swings in the market.
Of course, your investment time horizon isn’t the only thing to consider, but the less time you have to achieve your investment goals, the more conservative you should be about taking on risk.
The second factor is how you feel about market volatility. Consider how you would react to different market scenarios. For example, when markets experience a downturn, it means you will at least temporarily experience a loss in the value of your investments. Does this make you feel panicked, or do you take a optimistic approach, knowing investing is a long-term game?
The more comfortable you are with a downturn, the more likely you are to fall on the higher end of the risk tolerance scale. If market setbacks tend to unsettle you, you are probably more of a risk-averse investor.
Importantly: There’s nothing wrong with either reaction. The most important thing is that you have an investment strategy that you can feel good about and that meets your goals.
Your risk profile is specific to you—to your investment goals, your timeline to meet them and your emotional response to market volatility.
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