The balance between risk and reward is central to any investment proposition, while it’s fair to surmise that some asset classes are inherently riskier and more volatile than others. There’s a world of difference between investing in blue-chip, dividend stocks, and cryptocurrency assets, for example, and you’ll need to build your portfolio based on your underlying appetite for risk and existing capital holdings.
We’ll explore the concept of risk tolerance in investment below, while asking how you can match this to the relevant investment assets.
What is Risk Tolerance?
In simple terms, risk tolerance refers to precisely how much loss you’re prepared to take on within the confines of your investment portfolio.
More specifically, your risk tolerance should be represented by the amount of money that you’re prepared to lose in the pursuit of investment returns, and this will be impacted by a wide range of factors that are personal to you. These include:
Your Goals: Ultimately, the objective of financial planning is to accumulate wealth and secure your future security, with this process often translated into measurable, individual goals. Make no mistake; these will have a huge bearing on your risk tolerance and the precise types of asset class that you target, so you’ll need to develop a clear understanding of each one before you finalise your wider investment strategy.
The Timeline: If you’re a younger investor, it’s typically recommended that you take on increased risk in the pursuit of larger returns. Conversely, those approaching retirement are often advised to place fixed-income bonds and dividend stocks at the epicentre of their portfolios, in order to generate more reliable and incremental returns that don’t leave you over-exposed.
Your Personal Comfort Level: The amount of capital that you have may also impact risk appetite, but as individuals, we typically have an innate approach to risk taking and management in all walks of life. You’ll definitely need to factor this in when choosing viable investments and distributing your capital, as it’s crucial that you can rest easy and remain comfortable with the individual decisions that you make.
Matching Investments With Your Risk Tolerance
By considering these factors and making them a part of your decision making process, you’ll find it far easier to match asset classes to your desired level of risk tolerance. As we’ve already touched on, risk-averse or older investors could create a portfolio that’s largely split 60/40 between selected stocks and bonds, creating access to incremental returns that can be sustained over time.
Conversely, the volatile forex market may be a little more appealing for risk-hungry or cash-rich investors, particularly those who haveaccessed free capital through a welcome bonus on their trading account.
Regardless of how you proceed, however, it’s crucial that you utilise available risk-management tools like stop losses. Stop losses work by automatically closing positions once they’ve incurred a predetermined level of loss, based on your underlying risk profile and desired returns.
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