Risk Tolerance Is About You, Not the Market
Surveys show that tolerance for investment risk rises and falls with the stock market. In mid-2008, 36% of mutual fund investors said they were willing to accept substantial or above-average risk for the potential of substantial or above-average gain. The percentage plunged to 30% the following year, when the market hit its recession-era low, and dropped to 28% by 2012. Since then it has trended slowly upward to 34% in 2017.1
It’s not surprising that investors feel more bold when the market is booming and more cautious when it is down, but this behavior can be counterproductive. You might invest too heavily in riskier investments when prices are high and sell when prices have dropped, taking a loss and leaving you out of potential gains when the market rises again. If you become overly cautious and choose only low-risk investments with little potential for gain, your savings may not keep pace with inflation over the long term.
Your risk tolerance should be a fundamental component of your investment strategy, based on your own situation rather than market performance. Your tolerance may drive some of the decisions you make when the market rises and falls, but it should only change as your own circumstances change. Here are some factors to consider.
Your time frame. In general, younger people can take higher risk because they have longer to recover from potential losses and to benefit from potential gains. However, if you have a more immediate goal, such as saving for college, your time frame may be shorter than if you were focusing primarily on retirement.
Your goals. You may have to assume more risk if you anticipate an expensive retirement lifestyle. However, be careful not to assume too much risk just because you want to spend more.
Other sources of income. If you are confident that you will receive retirement income from another source, such as a pension, a business, or an inheritance, you may be able to assume more investment risk. It’s generally not wise to place too much emphasis on Social Security in your calculations.
Your investor personality. Regardless of other factors, you have to feel comfortable with the risk you are taking. Will the risk of an investment substantially increase your stress level? If the answer is yes, you may be better off choosing a less risky investment.
Risk tolerance varies from person to person, and there is no right or wrong or one-size-fits-all approach. The key is to consider the factors that could affect your own risk tolerance and to make informed investment decisions appropriate for your situation.
All investments involve some degree of risk, and there is no guarantee that any investment strategy will be successful. The return and principal value of stocks and mutual funds fluctuate with changes in market conditions. Shares, when sold, may be worth more or less than their original cost.
Mutual funds are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.