Your tolerance to risk

The recent intense volatility in the share market together with falling share prices would have tested the tolerance to risk of most investors.

Investors who have been losing sleep over these movements in the market should perhaps consult their financial planners about whether the long-term asset allocation of their overall investment portfolios is appropriate for their personal tolerance to risk.

I am not advocating any sudden adjustments to your portfolio - far from it - however the suitability of your investment portfolio for your ability to cope with risk is always worth discussing with your adviser.

As a general rule, your adviser will most likely tell you that it is best to set an appropriate long-term asset allocation - and typically stay with it for the long haul, making carefully considered and appropriate adjustments along the way. A crucial point is that our personal circumstances, including our ability to cope with risk, continue to change, particularly as we grow older.

When the share market seems to be forever rising, a common trap is for many investors to gain an over-inflated view of their ability to tolerate risk. But opinions towards risk can quickly change in periods when a market turns down - and this can lead to rash investment decisions that are often driven by panic.

Factors to consider when assessing your tolerance to risk include your perceived ability to cope with times of extended volatility and downturns in asset prices, and, of course, your emotional ability to cope with risk. Younger investors with many years until retirement generally have a higher tolerance to risk than older investors with less time to make up for financial setbacks - and perhaps a need to draw upon their capital.

Dealing with personal tolerance to risk can be a delicate and complex matter.

Intense market volatility and falling share prices can unnecessarily scare investors away from growth assets. Shares, for instance, can perform the dual function of keeping inflation at bay and expanding our wealth over the long term.

Many investors who have perhaps the financial capability to deal with a higher-than-average level of risk simply do not have the emotional capability to do so. And the opposite is often true.

How many times have you witnessed investors who cannot afford to take risks from a financial perspective take what appear to be extreme risks? And many of them seem to have the emotional tolerance to do so.

In February, the Financial Planning Association of Australia (FPA) published a valuable and extremely timely booklet, The trade off: understanding investment risk. It is well worth a read: http://www.fpa.asn.au/files/PubTradeOff.pdf

As the FPA publication states: "Risk never goes away, but sometimes it's easy to forget it's there. Even when markets are performing strongly, and everything we touch seems to turn to gold, risk is the investor's constant companion."