If you are dipping your toes into the investment world, you’ll need to determine your risk tolerance before you can invest in ways that satisfy your individual needs and preferences. Learning more about risk tolerance - what it is and why it’s important in the first place - is important for building a portfolio that really works for you. 

The Definition of Risk Tolerance

Investopedia defines risk tolerance as “the measure of the degree of loss an investor is willing to endure within their portfolio.” It’s fairly straightforward in theory, but in practice, it can be a little more complicated. That’s because there are numerous things that will affect your overall risk tolerance from one day to the next, and you’ll need to take those things into consideration when you are managing your investment portfolio. Things like your time horizon and the overall amount of money you want to invest will affect your risk tolerance, too. 

There is Always Risk in Investing

Every type of investment carries some sort of risk. The stock market’s volatility, the current scope of politics, shifts in the economy, and even changes to interest rates can have a significant impact on your investments. However, some types of investments are inherently less risky than others, even within the same investment type. To better understand this, consider real estate and the stock market. Real estate as a whole can be generally less risky than the stock market because real estate has lower volatility; however, some real estate moves are inherently riskier than others. On the other hand, while the stock market is riskier than real estate at the macro level, you can invest in stable stocks that drastically reduce the inherent risk. 

Risk vs. Earning Potential

It’s important to also understand the relationship between risk and earning potential to be successful as an investor. In the broadest sense, the more risk that is involved, the more you can earn; conversely, the less risk that is involved, the less you have the potential to earn. Though there are some exceptions to this, they are rare. The goal with risk tolerance is to find a balance between how much loss you are willing to suffer and how much you want to earn over a specific period of time. To do this, you might choose to invest into high-risk, high-reward investments, but balance this out by also investing in some low-risk, low-reward options. 

Three Types of Investors

In terms of risk management, there are three types of investors: 

• Aggressive - An aggressive investor is one who has a high tolerance for risk. If you are okay with risking loss in order to see potentially fast and significant earnings. Generally, aggressive investors invest their funds into capital appreciation; much of their money goes into stocks or equity investments. 
• Moderate - A moderate investor is someone who wants to see their money grow and who can tolerate some risk. These investors tend to use a “balanced” investment strategy that consists of a combination of stocks, bonds, and cash. The lower risk of the bonds and cash balances the high risk of the stocks. 
• Conservative - Finally, a conservative investor is someone who will tolerate very little risk and volatility. This can be ideal in some situations, such as for older investors who have significant savings that they aren’t willing to risk for the chance at big earnings. They focus on liquid investments, such as CDs, money markets, and bonds. 

If you are struggling to determine your overall risk tolerance, you can search for an online assessment, but the absolute best way to get started is to reach out to a professional who can help you assess your risk and build a portfolio that truly works for you. It’s easier than you might think to get started when you have an experienced professional on your side.