Navigating Market Volatility: Determine Your Risk Tolerance


This is the second installment in an eight-part series: Navigating Market Volatility. In simple terms, market volatility is the relative rate at which the market goes up and down. Dramatic shifts can be scary, even for the most experienced investors. To keep market swings from making you anxious, take steps to help you respond to volatility in a deliberate way.

To read the first post in the series click here.

Navigating Market Volatility: Determine Your Risk ToleranceNavigating Volatility: Determine Your Risk tolerance

When you put your hard-earned money into investment vehicles like stocks, bonds or mutual funds, you take on certain risks: credit risk, market risk, business risk, just to name a few. All types of investments have inherent risk(s): a stock price may drastically decline; the issuer of a bond may default; even cash investments (U.S. Treasury bills or money market mutual funds) carry the risk of losing ground to inflation.

Taking on some risk is the price you have to be willing to pay if you want to achieve higher returns. In light of this risk-return tradeoff, you must determine your personal tolerance for risk when choosing investments for your portfolio.

Age Generally, the younger you are, the more risk you may be willing to take because you have more time to make up for any losses you might experience along the way.
Risk Capital If you are the primary earner for your family, for example, you may want to take on less risk than you would if you were single.
Net Worth The larger your investment pool, the more willing you may be to take on risk. Just make sure you can still manage comfortably if you experience any big losses.
Time Frame When do you plan to begin withdrawing the money? The markets are subject to short-term fluctuations. If you buy an investment with money you plan to use soon, you could be forced to sell when the price is down.
Timeline How long do you think you will need your money to last? As you get closer to retirement, many investment professionals recommend moving at least some of your assets out of more volatile equities (stock and/or stock funds) into income-producing bonds and/or bond funds. You may want to consider leaving at least a portion of your investments in equities (with growth potential) in case you live longer than you expected.

No matter what investment vehicle(s) you choose, the objective is always the same: to generate more cash for yourself in the future than you have today. If you keep all your savings under your mattress, for example, it is guaranteed you will never have more money than the amount you save. Inflation (the rate at which prices for goods and services increases) is also guaranteed to eat away at your purchasing power over time. So, actively avoiding all risk is also risky. By investing your money, the potential exists for you to come out ahead—perhaps even far ahead.

Click to read Part 3 of the series: Invest at Regular Intervals.

All investments are subject to risk, including the possible loss of the money you invest. Past performance does not guarantee future results. There is no guarantee that any particular asset allocation, or mix of funds, or any particular mutual fund, will meet your investment objectives or provide you with a given level of income.