Risk tolerance is a way of measuring how much variability in an investment’s returns you are willing to handle.

• Investment risk comes in many forms including inflation risk, liquidity risk, volatility risk and business risk.
• Risk and return are closely correlated. Conservative, low-risk investments tend to produce lower returns than aggressive, high-risk investments.
• In addition to your risk tolerance, factor in your age, time horizon, anticipated income, cash flow needs and other assets when making investment decisions.

If you had the chance to skydive, would you do it? Often times, your lifestyle’s risk appetite can be a good barometer of your investment risk appetite. In other words, if you would jump at the opportunity to leap out of a plane, you may also be comfortable taking high risks in your investment portfolio. Therefore, it’s important to make an honest assessment of your own risk tolerance. Often times, it’s hard to really know what you’re comfortable with until you’ve experienced losses.

Let’s review the fundamentals of investing risk tolerance. When you understand the various types of risk, you can select the one that is in line with your individual risk preferences.

Time Horizon

Your individual risk tolerance level is likely to change as you age and your finances advance. When you’re decades away from retirement and have a long time horizon, you may be more willing to invest in higher risk assets. As your retirement approaches, scaling back to a more conservative portfolio may suit your needs better and help you preserve capital.