Investment strategies must be tailored to meet each investor’s needs. One factor that must go into these decisions is the risk tolerance the person has. This refers to the person’s ability to endure market fluctuations and potential losses as they pursue the returns they desire.
There are many factors that have to be considered when assigning a risk tolerance to a person. This includes their financial situation, time constraints, goals and emotional comfort. An incompatibility between risk tolerance and portfolio may signal unsuitable investments.
Consequences of mismatched risk tolerance
Unsuitable investments can lead to stress for the investor. It can also lead to emotional reactions during downturns in the market. Some investors might even abandon a solid investment strategy because they perceive it as too risky.
If the unsuitable investments are too conservative for the investor’s risk profile, the portfolio may not reach their goals as they wanted. This can mean they won’t have the lifestyle they thought they would.
In regulated industries, ignoring risk tolerance can cross the line into unsuitability. Investment professionals are required to recommend strategies that align with an individual’s risk profile, financial goals, and personal circumstances. When this isn’t done, it can lead to disputes or regulatory violations.
Periodic reviews are critical
Risk tolerance isn’t static. It can shift with life events, income changes or simply a new perspective on market risk. A strategy that fits a person’s lifestyle at 30 may not be appropriate at 60. Regular portfolio reviews help ensure that investments remain suitable as the investor’s life evolves.
