When someone decides they're going to hike the Appalachian Trail or climb Mount Everest, they must start with the end goal in mind. There is a starting point and an ending point. To fully realize the goal, they must create a plan for how to achieve it. That plan includes contingencies for the many unknowns that could occur. Whether it's snow, rain, bears, or any other obstacle that might affect their progress, there has to be a way to adapt. As the saying goes, "Plan for the best but prepare for the worst." This is where Risk Tolerance comes into play.
What Is Risk Tolerance?
Risk Tolerance is the level of acceptance of danger or
uncertainty that a person has toward any known or perceived event. It's the
amount of pain a person is willing to endure to achieve their desired goals.
In our hiking or climbing example, people who embark on these adventures understand there's no guarantee they won't encounter wild animals or life-threatening weather events. Yet, they accept those risks because they value the feeling of accomplishment that comes with overcoming obstacles and reaching their goal.
The Same Is True for Investing
Every investor must face the reality that in the financial
world, there will always be risk. Most people only focus on what's called
Market Risk—the possibility that an investment might lose value due to an
unexpected downturn in the market.
People notice this risk easily because it's everywhere. The
market ticker scrolls at the bottom of news broadcasts. It dominates headlines
in online publications. Radio and TV updates announce how the market performed
that day, along with possible reasons why. It's nearly impossible to escape the
constant chatter about market performance.
However, Market Risk is only one of nine major risks that every investor faces in their financial plan. Understanding all of them is key to building a balanced strategy that can withstand life's uncertainties.
The 9 Types of Risk Every Investor Must Consider
- Market
Risk - The risk that an investment may lose value.
- Liquidity
Risk - The inability to convert an investment into cash quickly
without a loss in value.
- Inflation
Risk - The danger that the value of the dollar falls faster than the
growth of assets or investments.
- Interest
Rate Risk - The risk that the interest you're earning is lower than
what newer investments are paying.
- Reinvestment
Risk - The possibility that once a high-interest investment matures,
subsequent investments will offer lower returns.
- Tax/Regulatory
Risk - The chance that government policy changes could negatively
impact investments through new taxes or regulations.
- Geopolitical
Risk - The risk of wars, trade conflicts, or tariffs between countries
that can cause economic damage.
- Health
Care Risk - The risk that illness or injury could limit your ability
to work or become a significant drain on savings.
- Long-Term Care Risk - The risk of facing high medical and care costs later in life, especially during the final weeks or months.
Why Discussing Risk Is Essential
When investors meet with their financial advisor or
Certified Financial Planner, it's crucial to discuss these risks in detail.
Understanding each one provides a clearer picture of how to protect against
potential losses while positioning yourself for future growth.
At the same time, investors need to remember that not all
risks are bad. Taking on a certain level of risk often leads to greater
rewards. In fact, avoiding risk altogether can sometimes be more dangerous than
facing it strategically.
For example:
- If
someone avoids Market Risk, they may fall victim to Inflation Risk, as
their money loses purchasing power over time.
- If a
person locks their money into a long-term CD and later needs cash, they
might face early-withdrawal penalties that outweigh the interest earned.
These situations are unfortunate but realistic — and they highlight why proactive planning matters.
Balancing Risk and Reward
The wise investor understands their risk tolerance — how
much fluctuation or uncertainty they can handle without panicking or abandoning
their plan. Knowing your personal threshold helps you make better long-term
decisions, especially during volatile markets.
Everyone's risk tolerance is different. It's shaped by
factors such as:
- Age
and time horizon
- Financial
goals
- Income
stability
- Family
responsibilities
- Personal
experience with investing
For example, a 30-year-old professional saving for
retirement in 30 years may be comfortable taking more market risk for higher
potential returns. On the other hand, someone nearing retirement might
prioritize preserving capital over aggressive growth.
The goal isn't to eliminate risk — that's impossible. Instead, it's to balance risk and reward in a way that supports your goals and gives you peace of mind.
What Happens When You Ignore Risk Tolerance
Ignoring your risk tolerance can be costly — both
emotionally and financially.
If your investments are too risky, market downturns may
cause panic, leading you to sell at the worst possible time. Conversely, if
your portfolio is too conservative, your money may not grow enough to outpace
inflation or support your future lifestyle.
Without a clear understanding of risk tolerance, investors
tend to make reactionary decisions — chasing hot trends, moving in and out of
the market, or sitting on the sidelines during crucial growth periods.
A thoughtful, customized plan built around your comfort level helps you stay the course even when markets fluctuate.
The Value of Professional Guidance
A financial advisor can help you identify your personal risk
profile using tools and assessments designed to measure your tolerance
accurately. Once your profile is clear, your advisor can build a diversified
portfolio that aligns with both your comfort level and your financial
objectives.
A skilled advisor also helps you:
- Monitor
your portfolio's performance relative to your goals
- Adjust
your investments as your life circumstances change
- Stay
focused on long-term results instead of short-term market noise
Even seasoned investors benefit from a second set of eyes
and an objective perspective — especially during uncertain economic times.
Understanding risk tolerance is one of the most powerful
tools an investor can have. It's not about avoiding danger—it's about
recognizing and managing it intelligently. By knowing how much risk you can
handle, you can create a strategy that balances growth and security, allowing
your money to work for you even through life's inevitable ups and downs.
The goal is simple: make sure your money outlives you, not
the other way around.
Talk to your advisor about assessing your risk tolerance
today. If you don't currently have one, Contact Us to schedule a
conversation with one of our experienced Private CFOs. Together, we'll help you
find your comfort zone and create a financial plan designed to weather any
storm.
