Risk Tolerance Revealed

Risk as a concept is not understood by many and they believe risks to be same as loss. Similarly, they always confuse risk tolerance with loss tolerance. But both are different. Risk tolerance is all about how you feel while deciding on two different alternatives, while loss tolerance is all about how you feel when you actually suffer loss. Risk tolerance is related to how you make decisions. On the other hand, loss tolerance is related to how you react to an event.

Risk tolerance is also different from risk capacity. The later is the amount of money that you could afford to lose without putting the achievement of your financial goal in jeopardy. It represents an absolute, downside constraint on strategy selection, which must be taken account of, but it’s not the same thing as risk tolerance.

Risk tolerance is a personality trait. It distinguishes one individual from other and at the same time, gets influenced by both the nature – one that is ingrained in your genes and the one that you have nurtured as your experience.

Here we will use FinaMetrica Risk Profiling system to understand the risk tolerance.

There is no evidence of sub factors in financial risk tolerance—that is, there is no evidence of investment risk tolerance, employment risk tolerance or borrowing risk tolerance. There is only risk tolerance dependent upon individual personality trait.

Gender is a significant determinant of risk tolerance, and a female exhibit lower risk tolerance than a demographically equivalent male.

Age and marital status are found to be significant determinants of risk tolerance. While age has a complex relation, marriage decreases the risk tolerance.

Major world and financial market events have not been seen as having any significant impact on risk tolerance.

It has been seen that risk tolerance remains relatively stable over time; however, perceptions of risk can change. For example, if you are driving your car and you nearly meet an accident. You can either pull your brakes or perhaps proceed slowly or you can choose to drive at same speed. The change in driving speed will depend upon the perception of the driving risk, which has changed.