When it comes to investing, risk tolerance is the amount of risk you’re willing to take as an investor. We all have to take some degree of risk to enjoy any type of return. Different investors are comfortable with different levels of risk taking. Some advisors and investors like to categorize risk as being aggressive, moderate, or conservative. Others assign their risk tolerance a number between 1-10. No matter how you or your advisor decide quantify risk tolerance, one thing is certain: yours should not be changing frequently.
Andy Racheleff of Wealthfront recently blogged about the right and wrong reasons to change your risk tolerance. He listed good reasons for a risk tolerance change as: a major life change, a significant change in your liquid net worth, or a significant change in your income.
These reasons make complete sense, and I agree wholeheartedly with Andy. Things we cannot control happen during life, and these are all viable reasons to reassess your risk tolerance. Side note, if you’re working with an advisor and a major life event occurs, he or she absolutely must be informed.
“I want to be aggressive when the market is going up, and conservative when the market is going down.” Sounds great, right? So many investors feel this way regarding their risk tolerance, but market action is a terrible reason to alter your risk tolerance. Do you actually feel more comfortable taking additional risk or are you upset your more aggressive buddy made more than you last quarter? Likewise, have your time horizon and risk tolerance actually changed during a pullback or are you simply realizing that the market constantly fluctuates?
I get that everybody wants to have their cake and eat it too, but your risk tolerance cannot be in constant motion based on the stock market.