Understanding Your Risk Tolerance: Schwab's Investment Strategies

Risk tolerance is the level of risk an investor is willing to take. While risk can mean opportunity, excitement or a shot at big gains, it is also about tolerating the potential for losses, the ability to withstand market swings and the inability to predict what's ahead. Investors may find it difficult to predict how they will respond to a given set of market conditions, such as a down market, until it occurs. Risk capacity, or how much investment risk an individual is able to take on, is determined by their financial situation. It is more flexible than risk tolerance and changes depending on personal and financial goals, and the timeline for achieving them.

Risk tolerance is the level of risk an investor is willing to take

Behavioural scientists say "loss aversion" can colour your approach to risk. Essentially, the fear of loss can play a bigger role in decision-making than the anticipation of gains. Your financial capacity for risk may not square with your emotional tolerance for it. For example, an investor in their 40s probably has 20 or more years until retirement, which should allow them to invest aggressively. But some people simply can't tolerate the ups and downs of holding that much stock, regardless of their age or time frame.

Your risk capacity, or how much investment risk you are able to take on, is determined by your individual financial situation. Unlike risk tolerance, which might not change over the course of your life, risk capacity is more flexible and changes depending on your personal and financial goals and your timeline for achieving them. If you have a mortgage, your own business, kids approaching college or elderly parents who depend on you financially, you may be less likely to comfortably ride out a bear market than if you're single and not holding any major financial obligations.

A financial shock, like job loss, an accident that comes with expensive medical bills or even a windfall, can also affect your investment decisions by altering the amount of risk you're able to afford. It's difficult for investors to predict in advance how they'll respond to a given set of market conditions, such as a down market, until it occurs. Consider asking someone close to you to rate your risk tolerance. You might think you're comfortable with risk, but your spouse or a close friend may be able to identify patterns of behaviour that you're unable to recognise in yourself. Financial advisors are ideally suited to this role because their experience with a broad range of clients can lend some perspective on where you fall along the spectrum of risk tolerance.

Risk can mean opportunity, excitement or a shot at big gains

Risk tolerance is the level of risk an investor is willing to take. It can be difficult to accurately gauge your appetite for risk. Behavioural scientists say "loss aversion" can play a bigger role in decision-making than the anticipation of gains. Your financial capacity for risk may not square with your emotional tolerance for it. For example, an investor in their 40s probably has 20 or more years until retirement, which should allow them to invest aggressively. But some people simply can't tolerate the ups and downs of holding that much stock, regardless of their age or time frame.

Your risk capacity, or how much investment risk you are able to take on, is determined by your individual financial situation. Unlike risk tolerance, which might not change over the course of your life, risk capacity is more flexible and changes depending on your personal and financial goals, and your timeline for achieving them. If you have a mortgage, your own business, kids approaching college or elderly parents who depend on you financially, you may be less likely to comfortably ride out a bear market. A financial shock, like job loss, can also affect your investment decisions by altering the amount of risk you're able to afford.

It's difficult for investors to predict in advance how they'll respond to a given set of market conditions, such as a down market, until it occurs. Consider asking someone close to you to rate your risk tolerance. You might think you're comfortable with risk, but your spouse or a close friend may be able to identify patterns of behaviour that you're unable to recognise in yourself. Financial advisors are ideally suited to this role because their experience with a broad range of clients can lend some perspective on where you fall along the spectrum of risk tolerance.

Risk is also about tolerating the potential for losses

Your financial capacity for risk may not square with your emotional tolerance for it. For example, an investor in their 40s probably has 20 or more years until retirement, which should allow them to invest aggressively. But some people simply can't tolerate the ups and downs of holding that much stock, regardless of their age or time frame.

Your risk capacity, or how much investment risk you are able to take on, is determined by your individual financial situation. Risk capacity is more flexible and changes depending on your personal and financial goals—and your timeline for achieving them. If you have a mortgage, your own business, kids approaching college or elderly parents who depend on you financially, you may be less likely to comfortably ride out a bear market.

A financial shock—like job loss, an accident that comes with expensive medical bills or even a windfall—can also affect your investment decisions by altering the amount of risk you're able to afford.

Your financial capacity for risk may not square with your emotional tolerance for it

Risk tolerance is the level of risk an investor is willing to take. However, it can be difficult to gauge your appetite for risk accurately. Risk can mean opportunity, excitement or a shot at big gains, but it is also about tolerating the potential for losses, the ability to withstand market swings and the inability to predict what's ahead.

Risk capacity is more flexible and changes depending on your personal and financial goals, and your timeline for achieving them. If you have a mortgage, your own business, kids approaching college or elderly parents who depend on you financially, you may be less likely to comfortably ride out a bear market than if you're single and not holding any major financial obligations.

Market shocks are an inevitable part of investing, but that doesn't make them any easier to stomach. When the market is going up, it's easy for investors to think they're more comfortable with risk than they actually are. But whenever the S&P 500® Index drops into bear-market territory, people may be forced to confront their true risk tolerance.

Risk capacity is more flexible and changes depending on your personal and financial goals

Your risk capacity, or how much investment risk you are able to take on, is determined by your individual financial situation. Unlike risk tolerance, which might not change over the course of your life, risk capacity is more flexible and changes as your personal and financial goals evolve.

It's difficult for investors to predict in advance how they'll respond to a given set of market conditions, such as a down market, until it occurs. Consider asking someone close to you to rate your risk tolerance. You might think you're comfortable with risk, but your spouse or a close friend may be able to identify patterns of behaviour—such as your tendency to play it safe in other areas of your life—that you're unable to recognize in yourself.

Market shocks are an inevitable part of investing, but that doesn't make them any easier to stomach. When the market is going up, it's easy for investors to think they're more comfortable with risk than they actually are. But whenever the S&P 500® Index drops into bear-market territory, people may be forced to confront their true risk tolerance—as well as their capacity, or ability, to take risk.

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