Should You Believe What Your Risk Profile Says?

I don’t know about you but my risk profile says I am risk aware, risk tolerant and risk capable.  That is, of course, a lie.  I may be aware and possibly capable but I guarantee you I am not risk tolerant.  I am firm believer that risk tolerance is a myth and that it is inversely proportional to experience.  The more experience someone has the less risk tolerant they become.

High risk tolerance is for bullet-proof young people.

I have a slightly different version.  It says if I lose the money, I would miss it but I probably would not change how I live.  If the money means anything more than “I would miss it.” then the investment is not something I want to do.

There are some risks I am willing to tolerate that others are not, because of the most useful antidote for risk and fear.  Knowledge.  Sometimes even in depth understanding.  Knowledge and experience are necessary tools to risk sensitive decisions.

Ten miles or so east of where I live is the Indian River Reptile Zoo.  It is the work of Bry Loyst and is the only one of its kind in Canada.  You hear of Bry every time there is a problem with venomous or other dangerous reptiles.  He is the go-to guy when you have this kind of problem.

Do you think he has fear of these animals?  No.

Do you think he has high risk tolerance?  Yes.

Do you think he has high risk tolerance for everything? Probably not.  I don’t know him but I suppose he could be afraid of spiders or heights or fire or clowns or Asian small cap funds?  Who knows?

We know he is not afraid of dangerous reptiles.  We know that happens because he knows them, knows their capabilities, knows their limits and knows his own limits, responses and capabilities.  In a word, Respect.

A client will not have context about risk until they learn the capabilities and limits of certain investment classes.  In a constantly rising market, equity funds start to look both good and highly predictable.  That leads to serious trauma when they adjust as they must do.  Recall 2008 and early 2009.  Many “risk tolerant” clients discovered that their high risk tolerance did not include losing.

A client who knows enough about the investments must also know their own tendencies.  Do they take profits too soon?  Do they hold losers with a hope of recovery?  Do they project linear performance instead of volatile performance?  Are they objective or emotional?

Informed clients know what they are trying to accomplish, how they themselves tend to behave and how their particular investment tends to behave, have two expectations.

  1. Live well in the future.
  2. Sleep well in the meantime.

As a general goal, those two are not bad.

Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.  |  Twitter @DonShaughnessy  |  Follow by email at moneyFYI

3 Comments on “Should You Believe What Your Risk Profile Says?

  1. Interesting article! I know for me personally, things changed when I became completely debt free (including my house) and had an emergency fund. While I still consider myself slightly more conservative than many investing gurus….I have no financial stress in my life, including investing, whatsoever.

    Keep up the nice work!

  2. Pingback: What Is Your Fear Factor? | moneyFYI

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