Understanding the Role of Risk Tolerance in Long-Term Investing

Every type of investment is subject to specific risks and, as a result, may result in capital loss or failure to achieve the objectives set.

Carefully assessing your risk tolerance, preferably with the help of industry experts, is essential for choosing the right financial instruments and investment products, i.e. those that, even in the event of negative performance, will not cause unsustainable financial problems and will not lead to rash decisions.

For this reason, before you begin investing, perhaps by choosing to build your portfolio with Moneyfarm, it’s important to make sure you’re emotionally and financially prepared for the level of risk you’re willing to take on.

Below, we will focus on long-term investments and try to understand the role played by risk tolerance.

What Are Long-Term Investments?

When we talk about long-term investments, we are referring to those that involve committing your money for a period of more than 5 or 10 years. This category includes, for example, investments in:

shares
long-term bonds and government securities
the property market;
supplementary pensions;
gold

and so on.

Those who choose this type of investment must be prepared not only to give up the amount of money invested for a large number of years, but also to face fluctuations in market values, which, depending on the financial instrument or asset chosen, may be more or less significant and require investors to deal with periods of loss.

What Does Risk Tolerance Mean?

Before figuring out the role of risk tolerance in long-term investing, let’s try to understand what this term actually means.

Risk tolerance is the ability of an individual investor to withstand, both financially and emotionally, capital losses and fluctuations in market values. In particular, this factor helps to identify investments that, even in the event of negative performance or sharp price fluctuations:

will not cause the investor to panic
will not lead them to impulsively change their strategy
will not jeopardise their finances

Risk tolerance varies from person to person and is closely related, among other things, to the investor’s financial situation, personality and level of experience.

Risk Tolerance in Long-Term Investing: What You Need to Know

Long-term investments are not suitable for everyone. Before committing your capital to investments of this type, it is essential to ensure that your risk tolerance is in line with them.

In particular, to avoid making rash decisions or taking rash action – such as selling as soon as market values fall and buying back when prices tend to rise – or having to terminate the investment prematurely, it is essential to be sure that:

– you can withstand without anxiety or panic high levels of volatility, with frequent ups and downs

– you can keep your invested capital frozen for 5 or more years.

In addition, it is important to remember that the duration of the investment is not an indication of a guaranteed return. Once the time frame established when building the portfolio has elapsed, you may find yourself with a lower return than expected or, in the worst cases, with a partial or total loss of your capital.

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Adam Regan: Deputy Editor

Features and account management. 3 years media experience. Previously covered features for online and print editions.

Email Adam@MarkMeets.com