How Risk Tolerance Influences Your Financial Plan
This past year, market volatility prompted many investors to think about how much risk they’re willing to tolerate. An investor’s risk tolerance is how comfortable they are with potentially losing money in hopes of higher gains, depending on market performance. Whether or not last year has inspired a more aggressive or more conservative approach, investors should work with their advisor to align their risk tolerance with a comprehensive and personalized financial plan.
How is risk tolerance determined? The first step we utilize at Girard to establish risk tolerance is to have each client complete a questionnaire, so we can get a sense of how each investor feels in certain markets. This allows us to gauge their level of comfort with exposure to equities and bonds against their existing portfolio. If it doesn’t match up, we can suggest changes to make sure there’s an appropriate allocation. For example, if an investor has an aggressive portfolio with 70% in equities but their risk tolerance score is more conservative, we can work with that client to bring their portfolio into an allocation that better reflects their needs and comfort level.
What influences risk tolerance? Market volatility can cause temporary changes in an investor’s risk tolerance making it a less than ideal time to evaluate a portfolio. In February and March of 2020, when markets plummeted amidst news of the pandemic, many investors’ risk tolerances shot down because of a desire to be more conservative. However, while it was a sharp decline, it ended up being a short period of volatility. While an emotional response is normal, it may be wise to evaluate why that volatility caused so much anxiety and then review risk tolerance once there’s less volatility.
Risk tolerance can also change depending on someone’s stage in life. As an investor gets closer to retirement, they may become more conservative as their focus shifts to preserving capital rather than building it. Alternatively, since young investors have a longer outlook towards retirement and are still in the process of accumulating wealth, they may be more aggressive in their allocation. Other factors that can influence risk tolerance are income, debt, or if the individual is expecting to inherit assets in the future.
How does risk tolerance factor into a financial plan? Financial plans are created to help meet short- and long-term goals and allow investors to feel safe amidst daily market fluctuations and temporary market volatility. With the right financial plan, many investors, with the help of their advisors, have the potential to weather these market storms and maintain the integrity of their portfolios and finances. As you assess risk tolerance, it is also an opportunity to revisit a person’s financial plan. Advisors and investors can work together to reassess their portfolio and determine if they should stay the course or if a shift to more conservative or more aggressive investing is necessary depending on their financial goals. This is an ongoing process. Investors should examine their financial plan at least every three to five years to ensure it still aligns with their current risk tolerance and life circumstances and long-term goals.
With a constantly changing economy and fluctuating market, investors cannot escape the daily news of market predictions and speculations, but a financial plan properly aligned with an investor’s risk tolerance can help provide peace of mind. At Girard, we develop specialized financial plans to address our client’s concerns, needs, and values including their risk tolerance. Want to learn more about how your financial plan can help provide security in a volatile world? Reach out to a financial advisor to create or re-evaluate your financial plan.
This article is for general information purposes only and is not intended to provide legal, tax, accounting or financial advice. The information in this article, and any opinions expressed therein, do not constitute a recommendation or an offer to buy or sell any security or financial instrument. Viewers should consult with their financial and/or legal professionals before making any financial decisions.