We often talk about risk tolerance as though it were an upper limit on a negative, something like a pain threshold. But risk, in and of itself, is not necessarily a bad thing. Think about a rollercoaster: some rides can be too tame and others too scary. We can have too much risk or too little risk.
In financial matters we are trying to strike a balance between making the most of our opportunities and risking our financial well-being. And then there is the buzz. We know from FinaMetrica research that 20% of people say they have made a sizeable investment mainly for the thrill of seeing what happened.
So our objective should not be to minimise risk absolutely because if we do so we also minimize the upside potential, and the buzz. Rather we need to find a balance point that is right for us and, if we are giving advice, that is right for our client.
Usually, as advisors, the danger is that our clients will be taking what is for them too much risk. This comes about because typically clients cannot achieve their goals from their available resources at the level of risk they would prefer to take. The temptation here is to take too much risk, particularly if the advisor is (far) more risk tolerant than the client.
Occasionally, however, a client can achieve their goals from resources available at less risk than they would prefer to take. Here the danger is one of underachieving.
It all comes back to ‘nothing ventured, nothing gained.’ It's just a question of getting the balance right.
See Geoff Davey's prior blog for AdvisorOne.com on the connection between risk tolerance and financial success.