Can my risk tolerance change over time?

Can My 💡 Definition:Risk capacity is your financial ability to take on risk without jeopardizing your goals.Risk Tolerance💡 Definition:Your willingness and financial ability to absorb potential losses or uncertainty in exchange for potential rewards. Change Over Time?

When it comes to investing, understanding your risk tolerance is crucial. But one question that often arises is whether this tolerance can change over time. The answer is yes, though the shifts might be more subtle than many expect. In this article, we'll explore how and why your risk tolerance can evolve, and offer some practical advice on managing these changes.

Understanding Risk Tolerance

Risk tolerance refers to your ability and willingness to endure volatility💡 Definition:How much an investment's price or returns bounce around over time—higher volatility means larger swings and higher risk. in the markets. It's a personal measure that guides your investment decisions, dictating whether you lean towards aggressive growth investments or prefer the safety of bonds💡 Definition:A fixed-income investment where you loan money to a government or corporation in exchange for regular interest payments.. While each individual's risk tolerance has persistent traits, certain time-varying factors can cause it to shift.

Factors Influencing Changes in Risk Tolerance

1. Age: As you age, your risk tolerance tends to decline modestly. For instance, a 30-year-old might be comfortable with 80% of their portfolio in stocks, while a 60-year-old might reduce that to 50% to minimize potential losses as they near retirement💡 Definition:Retirement is the planned cessation of work, allowing you to enjoy life without financial stress..

2. Macroeconomic Conditions: Improvements in the broader economy💡 Definition:Frugality is the practice of mindful spending to save money and achieve financial goals. can boost your confidence in taking risks. When economic indicators such as GDP growth and employment rates are strong, investors might feel more optimistic about investing in riskier assets💡 Definition:Wealth is the accumulation of valuable resources, crucial for financial security and growth..

3. Market Performance: Market trends can significantly influence risk tolerance. During a bull market💡 Definition:20%+ sustained market rise from recent low. Characterized by optimism, economic growth, and rising prices. Opposite of bear market., when stock💡 Definition:Stocks are shares in a company, offering potential growth and dividends to investors. returns are high, many investors' comfort with risk increases. Conversely, in a bear market💡 Definition:20%+ sustained market decline from recent peak. Characterized by fear, pessimism, and falling prices. Buying opportunity for long-term investors., risk tolerance often decreases as investors become more risk-averse.

Real-World Examples

To illustrate, let's consider two different scenarios:

• Young Investor: At 25, Jane has a high-risk tolerance. She invests 90% of her $50,000 portfolio in stocks, aiming for long-term growth. As she ages and approaches 45, her risk tolerance decreases slightly. She opts for a 70% stock allocation with a $150,000 portfolio, balancing growth with some stability.

• Retiree: John, a 65-year-old retiree, holds a $500,000 portfolio. Initially, he had 60% in stocks, but as economic conditions improve and his confidence grows, he increases his stock allocation to 65%. This modest shift aligns with his improved risk tolerance due to favorable market conditions.

Common Mistakes and Considerations

Behavioral Bias Risk

One of the most critical mistakes investors make is allowing market emotions to dictate their risk tolerance. The tendency to become overly optimistic during bull markets leads to buying high, while fear during bear markets results in selling low. This behavior can erode your portfolio's value over time.

Regular Reassessment

While about 90% of investors don't experience significant changes in risk tolerance, it's still wise to reassess it every two to three years or after major life changes. Doing so ensures your investment strategy aligns with your current risk profile.

• Major Life Changes: Events like marriage, the birth of a child, or nearing retirement can subtly influence your risk preferences, making periodic reviews essential.

Consistency in Measurement

Using the same risk assessment tool over time provides consistency, helping you distinguish genuine changes in your tolerance from mere measurement discrepancies.

Bottom Line

While your risk tolerance can change due to factors like age, market performance, and economic conditions, your core risk preferences are relatively stable. Regularly reassessing your risk tolerance, especially after significant life changes, ensures your investment strategy remains aligned with your financial goals. Avoid letting market emotions sway your decisions, and maintain a consistent approach to managing risk. By understanding these dynamics, you can make informed investment choices that support your long-term financial well-being.