DEFINITION:
Risk tolerance is the degree of variability in investment returns that you are willing to withstand. In simple terms, it’s your comfort level with the ups and downs of your investments.
WHEN AND WHY IT’S USED:
Risk tolerance is used when creating an investment strategy to ensure that the portfolio matches your comfort level with potential losses. It plays a key role in selecting the appropriate mix of assets—like stocks, bonds, or cash—based on how much risk you can accept. When financial advisors design your investment plan, they assess your risk tolerance to help prevent uncomfortable surprises during market downturns.
IMPORTANCE IN COMMUNICATION:
Discussing your risk tolerance with your advisor is critical for ensuring that the investment strategy is in sync with your emotional and financial capacity for risk. Clear communication on this topic allows your advisor to tailor asset allocation and portfolio strategies that avoid unnecessary stress during market volatility. This mutual understanding minimizes the chance of making impulsive decisions during market downturns.
Additionally, a detailed conversation about risk tolerance builds trust and transparency. It enables you to ask informed questions about the risk-return tradeoffs of various investments and to adjust your portfolio over time. Ultimately, knowing your risk tolerance helps create a resilient investment plan that reflects both your financial goals and your personal comfort level.
EXAMPLES IN CONVERSATION:
“Can we review my risk tolerance and see if my portfolio still aligns with it?”
“How do you factor my risk tolerance into selecting specific investments?”