September 2022 – 15 min read
Investment risk tolerance is a way to measure your willingness and ability to handle a loss in the value of your investments due to market volatility.
Your willingness to take risk is tied to your personality and how much you’ll worry about your investments.
If you worry when the market changes, you probably have a lower risk tolerance and might prefer investments less likely to lose money but offer lower return.
If you’re willing to leave your money alone and stick to your long-term investment plan through ups and downs in the market, you probably have a higher risk tolerance.
If you aren’t sure what you’re comfortable with, ask yourself:
- Do I need the money I’m investing in the short term or long term?
- How would I react if my investment dropped significantly in value?
Understanding your risk tolerance can help you prepare for market changes and save you a lot of stress. You can determine your risk tolerance by completing this investment personality questionnaireOpens a new website in a new window.
The younger you are, the more time you have to recover from market downturns – particularly when it comes to your retirement savings. If you’re in your 20s and are saving for retirement, you should be better able to handle short-term changes in your investments.
Factors like your income and other assets, also play a role in your ability to take on risk.
That’s what “risk capacity” is – your ability to survive financial loss if your investments take a steep drop. If you have a higher risk capacity, you can stay the course and hopefully rebuild your assets over time if the market drops significantly.
If you have a lower risk capacity, you’d be severely impacted if the market dropped. For instance, if you’re retiring soon, you probably wouldn’t want to put a big chunk of your savings into a risky investment.
That’s why it’s important to adjust your risk tolerance as you age and your life changes.
When it comes to determining your risk tolerance, you’ll want to consider the various risks that go along with investing.
For the first risks, the best way to manage them is to diversify your investments with a mix of investments across different sectors, markets, countries and types of investments.
To help manage timing risk, you might consider purchasing your investment using dollar-cost averaging.
With dollar-cost averaging, you invest the same amount of money on a regular basis, regardless of the price of the investment. Over time, investing this way can lower your average cost per unit — compared to what you’d have paid if you'd bought all your units at the same time when they were more expensive than the average.
Risk tolerance comes down to your comfort level and preferences and your real-world financial situation. It’s important for these 2 areas to line up. If you’re very willing to take risk, but unable to recover from market drops, you could run into real challenges.
Once you determine your risk tolerance, you’ll be able to recognize the type of investor you are.
Conservative: Your risk tolerance and capacity are lower. Your investments will likely include fewer stocks and more bonds or money-market assets (which usually offer steady returns with less fluctuation in price).
Moderate: You might be somewhere in the middle, perhaps someone with a higher risk tolerance but a lower risk capacity. Your investments might include a mix of stocks and bonds for a more balanced approach.
Aggressive: You have a higher risk tolerance and capacity and accept that you might see big swings in your investment value over time. You’re likely looking for bigger potential returns. Your investments are likely mostly stocks (as opposed to bonds) from big and small companies.
You can even choose investments that offer diversification and are prepared for specific levels of risk.
You’re in control of assessing your risk tolerance and how much risk you take on. But you don’t have to do it alone – there are experts who can help. Talk to your advisor to:
The information provided is based on current laws, regulations and other rules applicable to Canadian residents. It is accurate to the best of our knowledge as of the date of publication. Rules and their interpretation may change, affecting the accuracy of the information. The information provided is general in nature and should not be relied upon as a substitute for advice in any specific situation. For specific situations, advice should be obtained from the appropriate legal, accounting, tax or other professional advisors.