Risk tolerance is a crucial aspect of investing that guides how you allocate assets and manage your portfolio, but it can change over time due to shifts in both external market conditions and personal circumstances. Understanding how these factors can influence your risk tolerance is important for managing your investments and aligning them with your current comfort level and financial objectives. Let us take a closer look at how market conditions and personal circumstances respectively can affect risk tolerance, and how to incorporate these considerations into your portfolio.
Changes in market conditions
- Market volatility: When markets become more volatile, some investors may experience increased anxiety or fear about potential losses. This heightened emotional response can lead to a lower risk tolerance as investors seek to reduce exposure to risky assets.
- Economic downturns: During economic downturns, concerns about job security, income stability, and the overall health of the economy may lead investors to adopt a more conservative stance. They may prefer safer, more stable investments to protect their capital.
- Bull markets: In contrast, during prolonged periods of strong market performance, investors may become more confident and optimistic about future returns. This can lead to an increased risk tolerance as they seek higher returns by taking on more risk.
- Interest rate changes: Fluctuations in interest rates can impact the performance of various asset classes, influencing investors’ preferences for different types of investments. Rising interest rates may make fixed-income assets, that are considered lower risk investments, more attractive, while falling rates can drive investors towards higher risk equity investments that will yield higher returns.
Changes in personal circumstances
- Life events: Major life events such as marriage, the birth of a child, divorce, or the death of a loved one can prompt a reassessment of financial goals and risk tolerance. For example, a new parent may prioritise capital preservation over aggressive growth as they are mindful of new expenses in their immediate future.
- Career changes: Job changes, promotions, or job loss can impact financial stability and future income expectations. These changes may influence an investor’s willingness to take on risk as their future may be less certain.
- Age and time horizon: As investors age, their time horizon shortens, and they may prioritise capital preservation overgrowth. This natural progression can lead to a lower risk tolerance as investors approach retirement.
- Health concerns: Health issues can impact an investor’s financial stability and planning horizon. For instance, significant medical expenses or changes in long-term care needs may prompt a more conservative approach to investing.
- Financial status: Significant changes in financial status, such as a windfall, inheritance, or debt reduction, can influence risk tolerance. A stronger financial position may allow an investor to take on more risk, while financial difficulties may lead to a more cautious approach.
Adapting to changes in risk tolerance
- Reassess your portfolio: If you notice a change in your risk tolerance, reassess your investment portfolio to ensure it aligns with your current comfort level and objectives. Consider adjusting your asset allocation and investment strategy accordingly.
- Communicate with your advisor: Keep open lines of communication with your financial advisor. Discuss any changes in market conditions or personal circumstances that may impact your risk tolerance and investment strategy.
- Stay informed: Staying informed about market trends and economic developments can help you better understand how external factors may affect your risk tolerance. One effective way to stay informed is to read commentary available on asset manager’s websites or fund fact sheets. Investment experts within asset management businesses’ teams usually communicate their few of the economy and markets on either a monthly or quarterly basis within these commentaries. This will provide valuable insight into how they view markets and how they are expecting future trends to unfold.
Risk tolerance is not static; it can change over time as a result of shifts in market conditions and personal circumstances. Being mindful of these changes and proactively adjusting your investment strategy can help you maintain a balanced and resilient portfolio that aligns with your current financial goals and risk tolerance.
