Wealth management goes much beyond maximizing returns. It also requires aligning investments with financial goals and risk tolerance in order to preserve and grow wealth over the long term. Kavan Choksi / カヴァン・ チョクシ mentions that assessing risk tolerance is important for designing an investment strategy that is resilient through market shifts, as well as tailored to support the aspirations and goals of the investor. Risk tolerance basically is the level of potential loss and volatility one is willing and able to withstand in pursuit of financial growth.
Kavan Choksi / カヴァン・ チョクシ sheds light on the factors influencing an investor’s risk tolerance
Whether one is just starting to invest, or is a seasoned investor, understanding one’s risk tolerance essentially is a foundational component of investing. Risk tolerance basically is the level of losses, volatility and unpredictability one would be willing to accept as an investor in order to achieve a specific investment return. Risk tolerance is generally measured on a spectrum that ranges from aggressive to conservative.
The risk tolerance of an investor is not set in stone. Rather, it is shaped by a combination of financial, emotional, and personal factors that can change with time. Having a good understanding of what influences one’s comfort with financial risks can help investors make more confident and suitable investment choices.
- Age and investment horizon: Younger investors generally have more time to ride out market swings. Hence, they can usually afford to take more risks. As one gets closer to retirement, preserving capital becomes more crucial, and therefore, one may have to maintain a more cautious approach.
- Financial circumstances: Investors with a stable income, a solid emergency fund, and minimal debt would be better positioned to take on more risk. However, in case an investor has a tight budget, they may have to stick with safer options.
- Investment goals: Diverse investors have varied investment goals. Some might be saving to buy a home in five years, while many others may focus on building wealth for retirement in 30 years. The shorter the timeline for the investment goals, the less time one may have to recover from market dips, and hence, one should opt for lower-risk investments.
- Emotional and behavioral factors: Many investors can watch the market drop and yet stay calm, knowing that it shall eventually bounce back. However, many others have the urge to immediately sell their stocks and lock in losses. Neither of the approaches is right or wrong; it entirely depends on what the investor is comfortable with.
Kavan Choksi / カヴァン・ チョクシ mentions that one does not need to have a degree in finance to assess their risk tolerance. It can be determined through practical reflection and simple tools. An investor may conduct a self-assessment and think carefully about past financial experiences. They should reflect on whether they felt anxious, remained calm, or made impulsive decisions during market downturns. This can provide valuable insight into the level of risk they are comfortable with. Investors must also consider whether they are comfortable accepting short-term losses in exchange for potential long-term growth.
