When creating a long-term investment plan, one of the most important—and often underestimated—steps is understanding your risk profile. This insight helps shape how your portfolio is constructed and how you’ll likely react when markets move. When your investments align with your true comfort level, you’re more likely to stay the course and avoid emotional decisions that could set you back.

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What Is a Risk Profile?‍

Your risk profile reflects how much market fluctuation you’re willing and able to tolerate. In other words, it’s your comfort level with the possibility of short-term losses in pursuit of long-term gains. Some investors are unfazed by market volatility, while others feel stressed at the first signs of a downturn.

This profile is influenced by your personality, financial situation, investment experience, age and goals. It’s also not fixed—your risk profile can and should evolve as your life circumstances or outlook change.

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Understanding Risk Tolerance and Capacity‍

Risk tolerance refers to your emotional ability to handle investment losses, while risk capacity speaks to your financial ability to absorb those losses. Together, they define your overall risk profile.

To assess your risk tolerance and capacity, consider the following:

• Income Stability: If you have a steady job or multiple income streams, you may be able to take on more investment risk.
• Savings and Emergency Funds: A strong financial cushion can allow you to weather market downturns without panic.
• Financial Goals: Short-term goals typically require more conservative investments, while long-term goals may benefit from a growth-oriented strategy.
• Emotional Reactions to Loss: If the idea of a market drop makes you anxious or keeps you up at night, a lower-risk portfolio may be a better fit.
• Time Horizon: Younger investors can often accept more risk, given the time available to recover from setbacks. Those nearing retirement, however, may need more stability.
• Investment Knowledge: Experienced investors may feel more confident staying invested during downturns, while newer investors may prefer a more cautious approach.

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How Different Investments Carry Different Levels of Risk‍

Not all investments are created equal when it comes to risk. Here's a simplified breakdown:

• Stocks: Offer strong long-term growth potential, but are often volatile in the short term.
• Bonds: Generally more stable than stocks, with lower but more predictable returns.
• Cash and Equivalents: Include GICs and money market funds. These are highly stable but offer minimal growth, and may not outpace inflation.
• Alternative Investments: Such as cryptocurrencies, private equity, or hedge funds, can offer high returns but are typically volatile and less liquid.

Choosing the right mix depends on your comfort with these risks and how they align with your financial plan.

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Why Aligning Your Portfolio with Your Risk Profile Is Crucial‍

A mismatch between your portfolio and your risk profile can have real consequences. If your investments are too aggressive, you may panic during a downturn and sell at a loss. If they’re too conservative, you may not generate the returns needed to meet your long-term goals.

Example:
Investor A invests mostly in stocks to meet a 6% growth target but panics during a market drop and sells at a loss.
Investor B avoids risk entirely with GICs but earns returns that fall short of what’s needed.
In both cases, the issue isn’t the market—it’s the misalignment between the portfolio and the investor’s true risk profile.

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When Partners Have Different Risk Profiles‍

It’s common for couples or business partners to have different risk tolerances. One may be more risk-averse, while the other is more growth-oriented. In such cases, a balanced approach or separate investment strategies may help accommodate both perspectives. A portfolio manager can help navigate these differences and recommend a solution that fits both parties.

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How Portfolio Managers Assess Risk Profile‍

Portfolio managers often use a formal questionnaire to assess your risk profile. This typically evaluates:

• Investment Goals and Timeline: For example, saving for a home in two years calls for lower-risk investments, while saving for retirement in 30 years allows for more growth-oriented choices.
• Reactions to Market Scenarios: Would you sell, hold, or buy more if the market dropped 20%? Your answer reveals a lot about your comfort with volatility.
• Current Financial Needs: If you rely on your investments for income, a conservative portfolio may be more appropriate. Conversely, if your income is steady and you have emergency savings, you may be able to tolerate more risk.

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A Tale of Two Investors‍

Let’s look at how different risk tolerances shape investment strategies:

• Investor A (High Risk Tolerance)
   
  • Age: 30
   
  • Financial Situation: Stable job, significant savings, no debt
   
  • Goal: Retirement in 30 years
   
  • Strategy: 80% stocks, 20% bonds
   
  • Reaction to loss: Understands and accepts volatility
 
• Investor B (Low Risk Tolerance)
   
  • Age: 55
   
  • Financial Situation: Approaching retirement, moderate savings, some debt
   
  • Goal: Preserve capital over the next 10 years
   
  • Strategy: 30% stocks, 70% bonds
   
  • Reaction to loss: Prefers stability and is concerned about declines

In a 20% market drop, Investor A is likely to stay invested, confident in future recovery. Investor B will not see a significant drop in his portfolio given his more conservative assets. Understanding their own risk profiles allows each investor to build a portfolio they can stick with.

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Why Rebalancing Matters‍

Even a well-matched portfolio needs regular attention. Market shifts can cause your asset mix to drift from your original target. For example, if a portfolio meant to hold 80% stocks and 20% bonds grows to 90/10 due to stock gains, itmay be riskier than intended. Rebalancing brings the allocation back in line.

Life changes—like marriage, retirement, or a new job—can also affect your goals and risk tolerance. Periodically reviewing your portfolio ensures it continues to reflect your current needs.

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Build a Portfolio You Can Stick With

Your investments should support your goals—and allow you to sleep well at night. When your portfolio matches your true risk profile, you’re more likely to stay invested through ups and downs and ultimately reach your long-term objectives.

At Matco Financial, we work closely with clients to uncover their unique risk profiles and design portfolios that reflect both their financial goals and emotional comfort. If you’re unsure whether your current strategy aligns with your risk tolerance, we can help.