Risk tolerance is the degree of risk an investor is willing to take with his or her investments. An investor with a longer investment time horizon can generally tolerate more risk than one who needs to access retirement savings or investment returns in a shorter time frame, such as a few months or years.
For the short term, the volatility of the market can be a significant risk factor because the value of an investment may be down at the time funds are withdrawn. For the long-term investor, however, the risk of selling when the market is low generally decreases. Therefore, the more time you have in which to invest, the more risk you may be willing to accept.
Time is just one consideration in assessing risk tolerance. An individual's comfort level is important, too. For investments in asset categories that have a tendency to fluctuate, an investor should be aware that the value of his or her investments may drop from time to time. On the other hand, conservative investors must consider the possibility that returns may not keep up with inflation over the years.
All these factors go into choosing your asset allocation.