How do I determine my risk tolerance?

Your risk tolerance is specific to you and your life circumstances. Barring a major change in your life circumstances (new baby, loss of employment, etc) your risk tolerance should not change very often.

We are already accounting for your age in your portfolio, so risk tolerance should really be selected for your personality. Selecting an appropriate risk tolerance is important, because it helps you avoid volatility that might push you to abandon your portfolio strategy – one of the biggest mistakes an investor can make.

Risk tolerance is a reflection of the tolerance you have to short-term volatility, before you begin to worry or change your portfolio strategy in response to market events. The market will go up and it will go down — that’s a certainty in life. Your risk tolerance is simply an indicator of how okay you may feel when it goes through larger swings.

What your risk tolerance is NOT is a reaction to how well the market is performing today, or how the news is painting the picture of current events. It would not be appropriate to lower it when markets are doing poorly and raise it when markets are doing well. By then it’s too late anyway. However, if you regularly worry about your investments or the markets in general, it might be appropriate to consider lowering your risk tolerance permanently.