If you want to build your wealth to help you achieve your life-long goals, investing is the track to pursue. However, this move entails a lot of risks — the higher the rewards at stake, the higher the risks will be. This is why if you’re working with a financial advisor, one of the first things he or she will do is to conduct a risk tolerance assessment.
Defining risk tolerance
In essence, risk tolerance refers to your ability to withstand any losses once your investments don’t go the way you want them to be — that is when the money you’ve invested is performing poorly and is not making any returns. Risk tolerance assessment is designed to measure the amount of risk you can tolerate, with “risk” being a comprehensive term that covers different factors such as market volatility.
Assessing risk tolerance
Risk tolerance assessment is conducted by handing out a survey to an investor. It is composed of different questions that aim to navigate through your investment profile and mindset — which types of investment you’re keen to pursue, what are the goals you’re planning to hit.
A financial risk tolerance questionnaire is basically a survey gauging the key factors that affect your ability to withstand things that can jeopardize your investment plans. These factors include:
Your objectives. Your goals in life will dictate how much money you need in order to achieve them.
Your age. Those who are nearing the retirement age tend to prefer less risky investments.
Your timeline. In relation to the bullet above, the longer your timeline (say, 50 years vs. 10 years), the higher is your capability to endure investment losses.
Your portfolio size. If you have a larger portfolio — and a more stable course of income — you may be able to take riskier investments.
Your life situation. Changes in life like getting married, having kids, or losing a loved one can significantly affect one’s investment outlook and priorities.
Your personal comfort level. Some people have that innate ability to stomach losses better — whether it’s about an investment or any other matter in life.
The changing nature of risk tolerance
How to assess risk tolerance is an important know-how for all parties involved in investing — the investor, the advisor, and the investee. However, it’s also important to know that a certain investor’s risk tolerance score can change over time. And these changes can be dramatically triggered by the factors stated above. This is why risk profiling is a crucial process that should be done regularly and with utter expertise.