Risk tolerance is one of the most important factors in your retirement plan. Some people are naturally wired to take risks, while others are wired to avoid risk. In terms of investing, risk tolerance relates to your ability to withstand losses. For example, if you’re investing for growth in the stock market, how much market shrinkage can you handle before you panic or your quality of life is affected?
Determining your risk tolerance at different stages of life is more than just knowing how much you do or don’t like taking risks. It’s about considering your age, timeline, savings, and most importantly, your specific retirement goals.
If you’re 60 and plan to retire in five years, it might make sense to start getting more conservative. If you’re 55 and don’t plan to retire for another 10 years, it could make sense to remain aggressive for a little bit longer.
The important thing to understand is that your risk tolerance can change. In fact, it should evolve according to the stage of life you are currently in. That’s because investing for retirement without considering risk tolerance is like driving a car blindfolded. Odds are, you’ll eventually regret it.
Let’s say you’re naturally wired to invest aggressively, and you remain overexposed to growth-based strategies as you near retirement, without considering the other factors that should help determine your financial risk tolerance.
There’s a strong chance you’ll learn a hard lesson about just how important those other factors are by the time you’re retired. On the flipside, let’s say you’re naturally risk-averse. So, you follow that instinct and invest ultra-conservatively without considering your age, timeline, and goals. In that case, you could miss out on opportunities to boost your retirement income. However, the consequences of not understanding risk tolerance aren’t just financial.
If your investment allocation is wrong for your risk tolerance, your retirement could be marred by constant stress, where you’re always worried that your money is at risk. That’s why it’s so important to work with a financial advisor who understands the complexities of planning and saving for retirement. By doing so, you can develop the right strategy with the right risk tolerance, so you can enjoy retirement with much less stress.
