What Is Risk Tolerance and Why Does It Matter?
Published on May 17, 2025
Risk Tolerance Explained: Why It's Critical for Long-Term Investing
Risk tolerance is your ability and willingness to endure fluctuations in the market. It helps define what kinds of investments make sense for your unique situation.
There are three key components:
Emotional tolerance:
How well do you sleep at night when your portfolio drops?
Financial capacity:
Can you afford to lose money in the short term?
Investment timeline:
The longer your horizon, the more risk you can usually take.
Understanding your risk tolerance allows you to build a portfolio that won't tempt you to panic sell or overextend.
Start by answering a few quick questions in our Investment Risk Quiz.
Why Risk Tolerance Matters
Your risk tolerance isn't just a theoretical concept—it has real implications for your financial well-being. Here's why it matters:
Prevents Emotional Decision-Making
When markets decline, investors often make their biggest mistakes. Those who've accurately assessed their risk tolerance are less likely to panic sell at market bottoms—one of the most common and costly investing errors.
Helps You Stay Invested
The most successful investors are those who stay invested through market cycles. Understanding your risk tolerance helps you build a portfolio you can stick with through good times and bad, maximizing your chances of long-term success.
Aligns Investments with Life Goals
Different financial goals require different approaches to risk. Your emergency fund should be low-risk and highly liquid, while your retirement portfolio (if you're young) can typically withstand more volatility for potentially higher returns.
Risk Tolerance Changes Over Time
It's important to reassess your risk tolerance periodically, especially after major life events like marriage, having children, or approaching retirement. What made sense in your 20s might not be appropriate in your 50s.
How to Measure Your Risk Tolerance
While our Investment Risk Quiz provides a comprehensive assessment, here are some questions to start thinking about:
- If your portfolio dropped 20% in a month, would you (a) sell to prevent further losses, (b) do nothing, or (c) buy more while prices are low?
- How soon will you need to access your investment funds? Sooner means lower risk tolerance is appropriate.
- Do you have stable income and an emergency fund to cover 3-6 months of expenses? If not, you may need to be more conservative.
- What's your investment experience? Those new to investing often discover their actual risk tolerance only after experiencing market volatility.
Remember, there's no "right" level of risk tolerance—only what's right for your unique situation. By understanding yours, you can build an investment strategy that helps you reach your goals while still being able to sleep at night.
Ready to discover your risk tolerance? Take our quick quiz to get personalized insights about your investing style.