Building Your Portfolio

Your Risk Tolerance

Both your age and your time frame for meeting specific financial goals play a role in determining your risk tolerance. If you're young and have a long time to meet your goals, you may have a higher risk tolerance than someone who is nearing retirement and is counting on investment income to live on for two or three decades.

But other factors may also affect your tolerance for investment risk. Your personality, personal experiences, and current financial circumstances also come into play. For instance, if you're a single parent, are responsible for the care of a sick or elderly relative, or have lived through a period of economic upheaval such as a major recession, you may be a more risk-averse, or conservative, investor. On the other hand, if you have a promising career, a generous salary, and little in the way of financial responsibilities, then you may be more comfortable in assuming greater investment risk.

Above all, you need to feel comfortable with the risk you're taking. If changes in the value of your portfolio keep you tossing and turning at night, or your instinct is to sell your investments every time the stock market drops, then you may want to consider shifting to a less volatile investment mix, perhaps one with a greater emphasis on predictable, income-producing investments, such as bonds and bond funds.

Or, if you're a risk taker by nature and have at least 15 years to meet your goals, then you may be comfortable allocating most of your assets to a diversified portfolio of stock, stock funds, stock ETFs, and certain fixed-income investments that have the potential to provide the strongest returns over the long run. But keep in mind that what starts out as a long-term horizon gets shorter and shorter as time passes. Your portfolio's asset allocation likely should change as your time horizon changes.

Keep in mind that investment risk doesn't mean staking your life savings on highly speculative investments like a new company that a friend is starting. (The only money you'd want to put in investments like that is money you can afford to lose.) But it does mean getting used to the fact that virtually all investments that have the potential to provide substantial returns will drop in value at one time or another—sometimes significantly.

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    Using Asset Allocation