March 3, 2023
How much are you willing to risk as a retail shareholder? That is a fundamental question for any individual investor and the key to understanding the idea of risk tolerance.
Simply put, risk tolerance is the amount of market volatility and loss you’re willing to accept as an investor. It is a fundamental question when determining what kinds of investments you’d like to make. And it is different for each and every retail investor.
Risk tolerance often changes over time. And it is different depending on how the retail shareholder uses his or her brokerage account. For example, an investor with a Robinhood (Tii:HOOD) account that they use to tinker in the market by investing in high-risk, high-reward stocks has a much higher risk tolerance than a retail shareholder sinking money into relatively low-risk assets in their Morgan Stanley (Tii:MS) retirement account.
That same individual investor with a retirement account might focus on assets that are much more aggressive earlier in their careers and shift to a more conservative mix of assets as they get closer to retirement. The risk tolerance for someone investing for retirement with a 30-year career ahead of them is far different than someone who is a few years from drawing on their retirement account. In general, the longer your investing timeline, the more risk you can assume because you have more time to recover from a loss.
Risk tolerance also depends greatly on the individual. Some retail shareholders hear the word “risk” and it puts knots in their stomachs. Others hear the word and it excites them and signals the potential for big gains. As an individual investor you need to ask yourself: Where to do I stand on that spectrum?
Regardless of where you stand, determining your level of risk tolerance should not wait until you are facing losses. Every retail shareholder should think about risk tolerance often – certainly before purchasing any asset.
Risk tolerance is slightly different than risk capacity – how much investment risk you are financially able to take on. It will not matter if your risk tolerance is high if you are not able to absorb any potential losses. Risk capacity relates to your financial situation and your ability to take losses to your portfolio. Someone making a healthy income with little debt probably has more risk capacity than an individual investor with lots of debt and other major financial obligations.
So how do you determine your risk tolerance? There are several helpful tools online that can help you understand your level of risk tolerance including this survey tool from the University of Missouri. Nearly every commercial brokerage house has a free risk tolerance survey or tool as well.
When retail shareholders figure out their risk tolerance, they can study the performance data from their portfolios to see if outcome matches their expectations. If the performance is low because assets are stuck in more conservative investments such as bonds and cash, a retail shareholder might shift some assets into more volatile investments such as stocks. The opposite is true as well. An individual investor who has a low risk tolerance and finds that their portfolio is losing more than gaining might shift some assets into lower risk areas.
Experienced investors often diversify to reduce shocks to their portfolios, blending some high-risk, high-reward stocks with more conservative assets. A moderate risk-tolerant investor may choose to invest in a 60/40 structure which may include a 60% investment in stocks, 30% in bonds and 10% in cash, though each individual investor must determine what feels right to them.
According to an old Wall Street saying, “You can eat well or you can sleep well.” Eating well refers to the higher-risk assets (such as stocks) that can lead to significant wealth. Sleeping well means that a portfolio filled with lower-risk assets might not make you rich, but can help you avoid losing sleep to worry. So, what is your risk tolerance?
TiiCKER was created for fan-first, brand-first public companies—with exclusive perks served-up weekly to shareholders. Own stock? Connect your brokerage account to view more than 130 perks waiting for you right now!
©2023 TiiCKER. All rights reserved.