What’s My Investing Risk Tolerance?

Investing in the stock market opens up real opportunities to grow your money over time. The key is to find the right strategy for you. It all depends on how much risk you want to take on. Investing risk tolerance measures your comfort level with potential losses as the markets move up and down. 

• People with a higher risk tolerance in their investing are more comfortable knowing their investments might swing up or down in the short term. They’re willing to ride out short-term market fluctuations in the hopes of realizing bigger returns.
• People with a lower risk tolerance prefer steadier, more predictable growth. This approach is usually more stable, but the tradeoff sometimes means lower returns.

Neither option is wrong, of course. They’re just different. When you know your risk tolerance, you can pick investments that help you build wealth in a way that suits you—whether you’re saving for short-term goals like buying a home or long-term goals like your retirement.

What is risk tolerance and why does it matter for new investors?

Investing risk tolerance is your comfort level with uncertainty in your investments. Think about how you might feel if the stock market dropped 10% in a week or if the value of your investing portfolio bounces around when the markets fluctuate. Some investors can watch their account balance dip without worry. Others get anxious and want to sell everything.

Risk tolerance matters because it helps to shape your investment strategy. If you pick investments that are too risky for your comfort level, you might panic and sell at the wrong time. If you play it too safe, you might not earn enough money to reach your financial goals. The sweet spot is to find investments you can stick with through both good markets and rough patches.

For new investors, it’s important to determine your own investing risk tolerance so you can start on solid ground. You’ll be able to decide which investments would be best for you to consider and which ones to skip for now. Staying inside your risk comfort zone can help you avoid making emotional decisions that could hurt your long-term success.

Key factors that influence your risk tolerance

Your risk tolerance isn’t just a gut feeling. It’s rooted in several important factors that shape how much risk you’re willing to take on with your investments.

Your time horizon and financial goals

Time horizon means how long you have until you expect to need your money. If you’re 25 and saving for retirement, you’ve got roughly 40 years to stay invested. You’ll be able to handle more investing risk because you’ll have time to recover from market downturns.

On the other hand, someone who’s 55 and plans to retire at 65 only has 10 years until they need to start pulling money from their investments. A major market drop close to their retirement date could seriously affect their plans. 

Your goals matter, too. Saving money to make a down payment on a house in 3 years requires a different strategy than saving money for your retirement in 30 years. Short-term goals usually call for less risky investments. Long-term goals give you room to take on more risk for potentially higher returns.

Your income and savings

If you have a stable income and a healthy emergency fund, then you probably can afford to take on more investment risk—if you’re comfortable with it. You’d have a financial cushion if your investments dropped. Someone who’s just starting out with limited savings and a lower salary might want to be more cautious in their investments. They’d need to build up their financial foundation first. 

Your current life situation

Big life changes can shift your risk tolerance. Getting married, having children, buying a home or changing careers all affect how you think about money and how much risk you’re willing to accept in your investments. For example, a military PCS move might mean you need your cash to be more accessible for a while. Starting a family often makes people more cautious about how they choose to invest their money. Your investment strategy should adapt as your life changes.

Your comfort level with market fluctuations

Everyone handles stress differently. If you check your portfolio daily and feel sick when it’s down, you probably have a lower risk tolerance. If you can watch the market drop 20% and think, “This is a good buying opportunity,” then you have a higher risk tolerance. What matters most is that you’re honest with yourself about how market swings affect you. Your investments should match your personality.

Risk tolerance vs. risk capacity

Knowing what shapes your risk tolerance is a great starting point. But there’s another piece of the puzzle: risk capacity. These two work together to help you create the right strategy for you, but they look at different things.

• Risk tolerance is emotional. This is how you feel about risk. Can you sleep at night when your investments drop? Do market swings stress you out? Think about your gut reaction to market volatility and its effect on your investment portfolio.
• Risk capacity is financial. This is how much risk you can afford to take. Even if you feel comfortable with risk, you may not have the financial cushion to handle big losses. Risk capacity looks at your income, savings, debt and other financial responsibilities.

You might feel brave about investing in high-risk stocks. But, if you don’t have an emergency fund, you have a lower risk capacity. That should guide your decision to take a lower risk approach. 

On the flip side, you might be nervous about market drops. But, if you have a steady income and a long time horizon, then you have a higher risk capacity. You could try investing options with a little more risk.

The best investment strategy considers both your risk tolerance and your risk capacity. This information helps you choose investments that fit your emotional comfort level and your financial reality. 

Quiz: What's my investing risk tolerance?

How to pick investments based on your risk tolerance level

Most investors fall into 1 of 3 categories: conservative, moderate or aggressive. Each approach uses different types of investments to balance risk and potential returns. You can use your answers from the risk tolerance questionnaire above to think about what kinds of investments might be best suited for you.

Conservative risk tolerance

Conservative investors prioritize protecting their money over chasing big returns. If the idea of losing any money makes you uncomfortable, this might be your style.

Conservative investments often include a mix of bonds, index funds and mutual funds. These options offer steady, predictable returns. You won’t see dramatic growth, but you won’t see dramatic losses either. Your money can grow slowly and safely. The tradeoff is that conservative investments might not keep pace with inflation over time. 

Conservative investing works best for short-term goals or money you’ll need to access soon.

Moderate risk tolerance

Moderate investors want growth but also value stability. You're likely willing to accept some ups and downs in exchange for better returns than conservative investments typically offer.

A moderate portfolio usually mixes stocks and bonds. You might decide to invest 60% in stocks and 40% in bonds, for example. This gives you exposure to stock market growth, with a cushion during downturns. This balanced approach works well for many people. You could have decent growth potential without having to deal with the unpredictable swings of an all-stock portfolio.

Moderate investing is a good choice if you’re saving for medium-term goals or if you want to make steady progress on your retirement savings.

Aggressive risk tolerance

Aggressive investors prefer to chase maximum portfolio growth potential. You're probably comfortable with significant short-term losses if it means you have a better shot at higher returns over time.

Aggressive portfolios focus heavily on higher-risk assets, including individual stocks and exchange-traded funds (ETFs). Aggressive investing gives your money the most room to grow, but you’ll need the time and temperament to ride out market volatility.

This approach makes sense if you’re young and have several decades until you retire, or if you have a high risk capacity and can handle watching your portfolio value drop 20% or more without panicking.

Using asset allocation tactics to diversify your portfolio

Asset allocation is how you divide your investment dollars across different types of investments. It’s one of the most important decisions you’ll make as an investor because it has a bigger impact on your returns than picking any individual stocks or trying to time the market.

The 3 main asset classes are stocks, bonds and cash equivalents. Each one behaves differently when market conditions change. Stocks might go up while bonds stay steady. Bonds might hold their value while stocks drop. Cash equivalents like money market accounts offer stability but minimal growth. 

When you spread your money across different asset classes, gains in one area can help offset losses in another. If your stocks drop 15% but your bonds stay flat, your overall portfolio won’t take the full hit. This is portfolio diversification in action! However, you should know that diversification itself won’t necessarily ensure you’ll earn a profit, nor does it guarantee against loss in a declining market. That’s why carefully evaluating where you’ll put your money is so important.

How to manage investment risk

Investing involves risk, but managing that risk doesn’t mean avoiding risk completely. You can use smart investment strategies to reduce the impact on your portfolio when markets don’t go your way. 

Here are some proven approaches that can help protect your investments while still giving them room to grow.

Diversify across investments

Don’t put all your money in one type of investment like a single stock. Spread it across different companies, industries and asset classes. That way, if one investment underperforms, others might pick up the slack to protect your overall portfolio.

Invest for the long term

Markets go up and down in the short term, but they’ve historically trended upward over long periods. If you’re investing money that you won’t need for at least 5 years, then you have time to ride out the dips. Think in decades, not days.

Use dollar-cost averaging

Instead of investing a large sum of money all at once, invest smaller amounts on a regular schedule. You might invest $200 every month, for example. Dollar-cost averaging means you can buy more shares when prices are low and fewer when they’re more expensive.

Keep in mind that using this method won’t guarantee profits or make you immune to losses during downturns. This is a slow, steady investment strategy. It’s designed to ease the effects of market ups and downs and lower your average per-share cost over time. You’ll still need to diversify your investing dollars among a variety of companies, industries and sectors to lower your risk and increase the likelihood of earning returns.

Rebalance periodically

Your target asset allocation can drift over time. Rebalancing means selling some of your winners and buying more of your other investments to get back to your target mix. Many investors rebalance once or twice a year.

Keep an emergency fund separate

Don’t invest money you might need in the next few years. Keep 3 to 6 months of expenses in a savings account or money market fund. This way, you won’t be forced to sell investments at a bad time just because you need cash.

Shape your ideal investment strategy

Ready to invest with confidence? Understanding the role that risk tolerance plays is an important first step to start investing. Navy Federal can help you turn this knowledge into a clear risk management strategy. Our investment advisors can help you better assess your risk profile, as well as look at your goals, time horizon and comfort with risk to help you create a personalized investment strategy. You can also explore Digital Investor, which offers both automated and self-directed investing tools designed to make investing a breeze.