lower risk tolerance

Understanding Risk Is Key to Investing

March 14, 2014

risk toleranceEach individual has a distinct risk tolerance level. Unfortunately, the standard questionnaire from financial planners may not paint an accurate picture of one’s risk preferences as it is not tailored to reflect every aspect of an individual’s financial life. While words like “tolerance” and “capacity” are used reciprocally by financial planners, the fact is that these words have different meanings to different people.

The term “risk capacity” is used to measure one’s financial ability to sustain risk. In the context of a practical financial arrangement, risk capacity considers one’s asset base, withdrawal, and liquidity needs in a given time period. An example of a very high risk capacity portfolio would be withdrawing $30,000 annually from an asset base of $1 million starting 15 years from now to fund periodic retirement payments. In this scenario, the portfolio will have sufficient means to sustain the retirement goals even if it experiences consecutive years of underperformance with the designated investment vehicle. (more…)