Understanding Your Risk Tolerance

April 5, 2018

Financial advisors typically ask clients to complete a risk tolerance questionnaire. Its goal is to help us understand your comfort level with certain stocks or aggressive investment strategies – if such a strategy supports your goals and lifestyle. The questionnaire asks things like, “What would you do if your investment dropped 10 percent? 30%?” In reality, how could you know the answer to this question? After all, we’re terrible predictors of our future emotions.

However, how individuals perform as investors is driven heavily by emotion. The number of times I’ve seen the above questions answered with, “I’d invest more money to lower my share price” is in direct correlation to the number of times I’ve seen people liquidate their holdings when the market tumbles. It’s almost impossible to know how you’ll respond to risk until something forces our hand. It’s at this time we should reassess your risk tolerance.

  • Did you lose sleep worrying about it and, ultimately, ask us to move to cash? If so, let’s dial it back and make you more comfortable for future volatility.
  • Did the volatility not phase you? Maybe we need to add to our risk exposure, so we aren’t leaving potential earnings on the table.

It is highly unlikely we’ll be able to accurately predict our emotional state as it relates to risk, turmoil or loss. However, if we do a better job of understanding how we feel as these things occur, we can better prepare ourselves for them in the future. Think back to 2008 when the market kept going lower; how did you feel? How did you react when this last bout of volatility happened?

Some fear is good. It reminds us what we’re playing for. Too much fear can be debilitating. It’s your advisor’s responsibility to recognize your emotional reactions and help coach you thorough them. Client-advisor relationships operate best when you lean on us for emotional support, and we build an investment plan around your risk tolerance.

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