Risk Tolerance - Meet Mr Risky and Mrs Cautious

Well, “the risk tolerance chat” is the investment equivalent of the “birds & the bees chat”, important stuff to say the least! 

Properly understanding your risk tolerance allows you to be invested in line with your goals and objectives instead of lying awake at night worrying what your investments are up to. 

Investment risk and risk tolerance, you’ve probably heard tons about it, but might still find yourself scratching your head thinking.. “what on earth is it?” 

What On Earth Is Risk Tolerance?

Risk tolerance is how much risk you can handle in your portfolio and is determined by your investment goals. For example, Mrs Cautious has modest financial goals and a long time to achieve them, therefore she doesn’t need to take on much risk and would likely have a low risk tolerance. After all, why take more risk than you need to?

On the other hand, Mr Risky has more ambitious goals and he’s in something of a hurry (think Friday evening rush hour commuters). Mr Risky is more likely to hit the gas and cut a few corners because, in his view, the reward is worth the risk.

Understanding where you sit between Mrs Cautious and Mr Risky is the art of risk profiling. 

Mr Risky Meets Mrs Cautious 

But what if you have the needs of Mr Risky but the personality of Mrs Cautious? For lots of people, the answer is just to invest in riskier stuff, right? 

Unfortunately not, and this is where we find a lot of people get stuck and worried about what their investments are doing (Up.. Down.. Up.. Down). 

If you’re in this situation, don’t jeopardise your nest egg. Instead, consider revising your investment goals to something a little more modest (do I really need 2 weeks in Fiji?), or putting a few more quid into your monthly savings plan. 

The Behaviour Gap

For years there have been attempts to simplify the process of identifying risk tolerance by using questionnaires and other tools, but the truth is there are no shortcuts (listen up Mr Risky).

One reason for this is the difference between what we think we would do in a particular circumstance and what we would actually when that circumstance arises. This is called the “behaviour gap”. 

For example, in the annual fire drill at the office, everyone knows not to fetch their coat / briefcase / favourite stapler, but we just can’t help it, we just need that stapler right?

This is the behaviour gap in action, we know what to do when the fire bell rings, but when it happens, we go searching for our belongings - and that’s the risk tolerance conundrum!

In an investment context, the equivalent is sitting in your financial adviser’s office, calmly informing them that you can live with a market fall of, say, 20%, but when you start to see red, the first thing you want to do is pick up the phone and scream SELL, SELL, SELL! 

At Jones Hill, we realise that properly understanding your risk tolerance is an important part of the financial process. That’s why we ask searching questions and listen attentively, so that we can design a portfolio that’s just right for you.