As part of your investment journey, it’s crucial that you understand how much risk is comfortable for you to take. This evaluation typically considers your financial goals, investment time horizon and source of steady income which could cushion against losses.
Financial goals that span both short and long-term time frames can have an enormous effect on risk tolerance. For instance, money saved toward purchasing a home today has an entirely different time horizon than saving for retirement in 2045.
Age
At different points throughout one’s lifetime, the amount of risk one is comfortable taking with investment decisions can shift considerably. This may be influenced by significant life milestones like marriage, having children or reaching retirement age as well as by experiencing devastating market crashes or witnessing similar financial catastrophes.
Please keep in mind that risk tolerance is subjective and not an objective indicator of how much you can withstand in terms of losses. Therefore, developing an understanding of your risk capacity – taking objective factors like net worth, savings versus spending and sources of income into account – is paramount to successful investing.
Income
Money availability plays an integral part in risk tolerance. It determines how long clients can wait before needing access to their investments, and also generates income through them.
Studies suggest that investors with greater wealth or disposable income or net worth are more willing to accept greater investment risks (Finke & Guillemette, Citation 2016). Other research has, however, shown income level as being an insignificant predictor of risk tolerance, particularly among those near retirement (Weber & Klement, Citation 2014; Grable Citation 2000).
As well as their overall financial situation and goals, clients’ personal disposition towards taking risk can also have an effect on their risk tolerance. If they fear loss more frequently they may prefer lower-risk investments like bonds. This could be caused by past experiences or individual characteristics like emotional resilience and knowledge level.
Investment Goals
Your investment goals can have an effect on your risk appetite. For instance, clients saving for short-term goals like funding vacations or purchasing new homes with more flexible timelines might be willing to accept more risk than investors investing for retirement with fixed deadlines.
By helping clients establish financial goals and prioritize them, you can gain a better understanding of their risk tolerance. Staying in contact regularly – such as after major life changes or their annual check-in – allows you to monitor any shifts in their risk tolerance as well as provide ongoing advice and guidance.
Risk tolerance can change for many reasons, including lifestyle adjustments, increased income or personal experience. Assessing clients’ risk tolerance and creating comprehensive portfolios tailored to meet their objectives and needs are integral parts of long-term financial success.
Time Horizon
Your client’s investment goals and timelines play a huge part in their risk appetite. For example, saving for retirement years from now may necessitate more aggressive investing than using money needed for home purchases in the next year or so.
With longer time horizons comes greater risks. Therefore, helping clients set financial goals and timelines is vitally important.
As your client’s risk tolerance and capacity may change over time, it’s essential that they receive regular check-ins – either annually or whenever significant life events take place – in order to make any necessary adjustments, such as rebalancing assets or altering portfolio strategies – thereby assuring investments align with goals and financial circumstances while preventing misalignments between risk tolerance and capacity which could otherwise lead to costly mistakes.