When it comes to investing, one of the most important yet often overlooked factors is risk tolerance. Understanding your personal comfort with risk is essential to building an investment strategy that not only performs well but also lets you sleep at night.
So, what is risk tolerance?
At its core, risk tolerance is your ability and willingness to endure fluctuations in the value of your investments. It’s about how much uncertainty and potential for loss you’re comfortable with in the pursuit of long-term returns.
Everyone wants to grow their wealth, but not everyone reacts the same way when markets drop. Some people see a downturn as a buying opportunity. Others panic and want to sell. Understanding your natural response is key to choosing investments that suit you, not just what’s trending.
Why risk tolerance matters
Imagine two people with the same goal, retiring at 65 with $2 million. One is confident with high growth investments and happy to ride out volatility. The other gets nervous when their balance dips even slightly. If they both had the same portfolio, one of them is likely to abandon the plan when markets get bumpy, which could derail long term success.
The objective is about matching your investment strategy with your goals and your personal comfort with risk.
The three sides of risk tolerance
- Emotional tolerance – How do you feel about market ups and downs? Do you stay calm or do you worry?
- Financial capacity – Can you afford to take a hit? If your investments dropped 20%, would it impact your ability to meet day-to-day needs?
- Time horizon – How long before you need to access the money? Generally, the longer your time frame, the more risk you can afford to take.
We work with clients to unpack all three. It’s not about labelling you as “conservative” or “aggressive” but finding a balance that aligns your investments with your life, goals and values.
How we help
It’s important we don’t implement a one size fits all portfolio. We’ll take the time to explore:
- Your past experiences with investing
- How you felt during previous market dips (like COVID-19 or the GFC)
- Your short and long-term goals
- Your ability to absorb financial shocks
We also use risk profiling tools but more importantly, we have the conversation. Often, clients discover that their true tolerance for risk is higher (or lower) than they first thought.
Final thoughts
Risk isn’t a bad thing, it’s a necessary part of building wealth. But unmanaged or misunderstood risk can lead to poor decisions at the worst times. By knowing your risk tolerance and working with advisers who understand it, you give yourself the best chance of staying the course and achieving your goals.
If you’re unsure where you sit on the risk spectrum, let’s have the conversation. At Empire, we’ll help you find the balance that’s right for you.
The information in this post is general in nature and does not take into account your personal objectives, financial situation or needs. You should consider whether it is appropriate for your circumstances and seek personal advice before making any financial decisions.
