What you need to know about risk tolerance

Investing can be confusing, especially for first-time investors. If you’re not careful about choosing your investments, you could be wasting your time and, more importantly, your hard-earned money.

But what are the things you have to consider when investing?

First, you need to know what your risk tolerance is.

What is risk tolerance?

Risk tolerance refers to how much risk you are willing to take when investing.

Knowing your risk tolerance level will help you build your investment portfolio and make better investment decisions. By aligning your portfolio with your comfort level regarding risk, you can create a strategy that aims for growth and minimizes stress during market fluctuations. This self-awareness enables you to choose investments that match your financial goals and time horizon, ultimately leading to a more effective and personalized investment approach.

Why is it important to understand risk tolerance when investing?

Understanding risk tolerance is important when investing because it helps determine how much volatility and potential loss you can comfortably endure in your investment portfolio. Your risk tolerance influences the types of investments you choose, ensuring that your strategy aligns with your financial goals and emotional resilience.

Investors with a higher risk tolerance may opt for aggressive assets like stocks, which can yield higher returns but also have greater fluctuations. Conversely, those with a lower risk tolerance might prefer safer investments like bonds or money market funds to preserve their capital. By accurately assessing your risk tolerance, you can create a balanced investment strategy that minimizes stress and maximizes the potential for achieving your financial objectives.

Factors that influence risk tolerance

The following factors determine the level of risk an investor can afford to take.

• Timeline. Every investor follows their time horizon based on their investment plans. Typically, you can take more risks if there is more time involved. If you need X money quickly, you generally go for a low-risk investment to safeguard your capital and ensure that your funds are available when needed. This alignment between your investment strategy and time horizon is important for effectively managing risk and achieving your financial goals.
• Goals. Each person has a unique financial goal. To achieve this goal, you need to follow a certain investment strategy designed to deliver such returns. Whether investing for your retirement or simply seeking to preserve your capital, your strategy should align with your risk tolerance and time horizon. Every investment strategy comes with its own set of risks that you need to consider, making it essential to choose options that not only help you grow your retirement savings but also fit your comfort level regarding potential market fluctuations.
• Age. Young individuals are generally keener to take risks compared to older investors. This is because younger investors have the time and capability to make more money and weather out market changes. While this is the common trend, risk tolerance varies regardless of age.
• Comfort level. Each investor handles risks differently. Some investors are more drawn to risks, seeking higher potential returns through aggressive investment strategies, while others tend to veer away from risks, prioritizing capital preservation and stability. This divergence in risk tolerance shapes their investment choices and strategies, influencing everything from asset allocation to the types of investment vehicles they prefer.

Types of risk tolerance

Risk tolerance is usually classified into three main types based on how much risk an investor can take.

Aggressive

Investors with an aggressive risk tolerance understand the market well and are not afraid of taking huge risks. These types of investors are experienced and familiar with large upward and downward movements in their portfolio. They have a long investment horizon and are willing to stay invested for a long time (at least 5 years).

While some aggressive investors have money to spare, there are some who have small capital to invest. A Unit Investment Trust Fund (UITF) in the Philippines makes investing in aggressive and more sophisticated funds affordable to the retail market. What a UITF does is it invests in diversified portfolios managed by professionals, making it accessible for retail investors with lower capital available. With low minimum investments and options catering to different risk tolerances, UITFs provide a practical way to grow wealth and engage with the financial markets, even for those with limited capital.

Moderate

Moderate risk investors are more wary when it comes to making investments compared to aggressive risk investors. They choose the risks they take and typically set a percentage of losses they can handle.

Moderate risk investors earn smaller gains than aggressive risk investors and do not suffer as badly if the market crashes. This balanced approach allows them to seek growth while maintaining a level of protection against significant market volatility, making it a suitable strategy for those who want to participate in the market without exposing themselves to excessive risk.

Conservative

Conservative risk investors take the least amount of risk among the three types. They invest in options that feel safe and prioritize market stability and investment liquidity over making a considerable amount or higher gains. Money market funds are a popular choice for conservative investors. What money market funds do is offer low risk and high liquidity, allowing for capital preservation while providing modest returns. Additionally, these investors often opt for other secure investments like bank certificates of deposit (CDs) and government securities to further safeguard their capital.

Invest accordingly

Finding out your risk tolerance will help you decide where to invest. They serve as a good starting point for the investments you should look out for. If you still aren’t sure what your risk tolerance is, don’t worry. Before investing (e.g., in UITFs), you will undergo a client suitability assessment at Metrobank in order to determine your risk.

Metrobank has multiple investment products suited for various risk tolerance types. Start investing with Metrobank today!