When deciding how to invest your money, it’s important to assess your tolerance for risk and your capacity for risk. It will be different for everyone but the components to consider are fairly universal.
Risk capacity is more about the objective side of investing – it’s the amount of risk you’re financially able to take on. Your risk capacity is determined by your current financial situation and your investment goals.
- How much growth do you need from your investments to reach your goals?
- Is it likely you’ll need to access this money in the short term?
- Is your current income sufficient and are your income sources stable now and into the future?
- How big a part of your total net worth is the investment you’re considering making?
If a prolonged downturn in the markets would have a significant impact on your overall financial situation, your risk capacity would be considered low. If you would be able to stay the course and not be forced to sell your investments to meet other financial obligations, then your risk capacity would be considered higher.
Risk tolerance is more about the feeling side of investing – it’s the amount of risk you’re emotionally able to assume. Your risk tolerance is based on how comfortable you are with the value of your investment portfolio going up and down.
- Would you lose sleep if there was a prolonged downturn in the markets?
- Will you be constantly checking how your investments are performing?
- Will the fluctuating value of your investments, cause your sense of well-being to fluctuate?
If, when your investments go down in value, you would be willing to stay the course and stay invested, then your risk tolerance would be considered higher. But if you would be more inclined to sell your investments in order to “stop the bleeding” and avoid losing more money, then your risk tolerance would be considered lower.
You may have a high capacity for risk but just aren’t comfortable with assuming too much risk. Alternatively, you may feel very comfortable taking on risk, but if your investments were to go down in value, the impact on your current financial situation would be significant.
Both your risk capacity and your risk tolerance can change over time. They should be reviewed and re-assessed periodically to make sure that your investments are still appropriate for you. If you think it’s time for a review of the level of risk in your portfolio, please let us know and we’ll arrange a time to go over it with you.