24 Jan 2017
Does Your Risk Tolerance Change Over Time?
Risk tolerance is an essential consideration when determining how to construct and maintain your portfolio over time. For one thing, many people don’t consider the difference between risk tolerance and risk capacity. Understanding how these two qualities differ—and how they interact in your life—can help you maintain an investment strategy that may enable you to better achieve your goals.
To get a better understanding of your ability to tolerate risk, it helps to look more broadly at the type of person you are. In fact, you might be surprised to learn that your risk tolerance really doesn’t change much over your lifetime, says Tyler Nunnally, U.S. strategist for FinaMetrica, which provides risk assessment tools for the financial services industry. That said, a person’s risk tolerance may vary across different areas of his or her life.
What does shift over time is your capacity to take on financial risk—that is, your ability to withstand a financial shock. Your risk capacity can be influenced by a variety of financial factors throughout your life, including loss of a job, saving for your children’s education or a health crisis that leads to unexpected medical bills—changes that will likely lead you to revisit both personal and financial goals and your timeline for achieving them.
Thus, it’s important to understand how your capacity and your tolerance for financial risk may interact.
“Can” versus “should”
A high tolerance for risk doesn’t mean you should take on more risk than necessary to achieve specific goals. Consider your time horizon. If you have a goal of sending your kids to college, with a time horizon of 15 years or more, it’s likely that you’d have time to recover from volatility in the market—so you could take on more risk. But as you move closer to your goal, your risk capacity may change because you may not have time to recover from a market drop.
Your level of wealth could also impact your capacity for risk. It may seem obvious that the more you’ve accumulated, the more easily you could weather a downturn in your portfolio without it affecting your goals or lifestyle. And while that’s perhaps true when you still have a long time horizon, you may eventually want to think about protecting your wealth for future generations.
I recommend revisiting your risk tolerance and capacity once a year when reviewing your investments and reconsidering your asset allocation, given how your life may have changed over the past 12 months. Ask yourself whether your goals, priorities or time horizon have shifted. Going through that exercise, you may find that you have a general level of risk tolerance but a different risk capacity for each goal.
To manage different goals, I suggest dividing investments into multiple buckets with different allocations. If you’re someone who enjoys excitement in your portfolio, consider taking those extra risks in a separate account using assets that you can afford to lose—in other words, where you have a greater risk capacity.
This material is issued by Charles Schwab, Hong Kong, Ltd. The information provided here is for general informational purposes only and has not been reviewed by the Securities and Futures Commission in Hong Kong.