The Ancient Greeks understood that one of the most important steps in development is to “know thyself.” While we often think of understanding ourselves in terms of self-reflection as we choose a career or a life partner, this is also good advice when it comes to investing. As you create an investing plan, you should understand your risk tolerance, which is a measure of what you can handle, financially and emotionally.
What is Risk Tolerance?
Your risk tolerance is the amount of variability you can handle in your investment returns. “Properly evaluating risk tolerance is essential for creating an effective investment plan that comfortably accounts for your goals,” says Carl Aschenbrenner, a portfolio manager at Miracle Mile Advisors.
There are two main types of risk tolerance when it comes to evaluating your investment portfolio:
- Financial risk tolerance deals with the actual numbers in your situation. “Time horizon, how much money someone has, how much money will be needed at future dates, and tolerance for volatility in the portfolio are all important factors to consider,” says Aschenbrenner.
- Emotional risk tolerance is more about how much you can stomach. Even if you have a high financial risk tolerance, with enough money to invest for the long term, you might feel uncomfortable, emotionally, with a lot of volatility, and that can affect the way you handle your portfolio.
Understanding how your risk tolerance impacts your portfolio is a big part of creating a successful investing plan.