Risk tolerance measures the degree to which an investor will accept risk in exchange for a better return.Few investing concepts matter more than risk tolerance. Investors need to fully fathom their ability to stomach large swings in their portfolio value. Those who assume more risk than desired may panic and sell securities at exactly the wrong time. Factors that influence risk tolerance include investing horizon and future earning capacity. Assets like a home or pension can also help guide the creation of a portfolio. Age and investing goals are always relevant, as well. For example, a 65-year-old investor may be less willing to allocate most of his investments to stocks than another investor who’s 45. That doesn’t mean the 65-year-old should keep everything in fixed-income or cash, but he probably wants less exposure to risk. The 45-year-old’s portfolio has more time to recover if it has a bad year. So she might be more willing to weather rough markets if she believes her strategy is sound. An investor with a low risk tolerance might put everything into high-grade bonds and sleep better at night. But low risk means sacrificing the potential for growth that’s more prevalent with stocks. Investors can assess their risk tolerance by answering questionnaires found online or with their broker. They can also review the worst-case returns for different asset classes to get an idea of the worst loss they could endure.
