I’ve been mulling over risk lately. Specifically, I’ve been wondering if people who’ve experienced significant losses become more risk averse.

According to Paul Resnik, co-founder of risk profile company FinaMetrica, risk profiling is a process for finding the optimal level of investment risk for each person. It is usually one of the first things a financial planner will do with a client (and if they don’t do one, alarm bells should be ringing).

 “We suggest people re-test their risk profile every two to three years or after a major life event,” Resnik is quoted as saying in an article on constructing a diverse portfolio. “We find your risk tolerance tends not to change but your financial needs will do over time.”

It was the second part of the quote that got my attention – “We find your risk tolerance tends not to change…”

Does that surprise you? Risk tolerance is the level of financial risk you are emotionally comfortable with. Wouldn’t you think that, as we grow older, we also get wiser, and by that, I mean more cautious? Less comfortable with risk?

And what about my underlying question that surely people who suffer losses become more reluctant to put themselves in a position when they could lose again?

What changes when it comes to risk, says FinaMetrica, one of the top risk profiling companies, is our capacity to handle it. We can’t afford to take on risky propositions as we get older because our investment time horizons are diminishing. In other words, we have less time to recover should we suffer a loss.

What is the perfect level of risk?

Profiling your risk will involve factors such as age, existing assets, expected retirement date, future earnings and financial outgoings as well as psychometric testing to suss out your emotional attitude to risk.

This is where Paul Resnik’s advice about rechecking your risk profile every few years and especially after a major life event rings true, because all the factors are variable.

Your adviser then goes about researching and proposing options that match your risk profile. This is where interference from well-meaning family members and friends can set things awry. Remember that blog from a few weeks ago about the retired banker advising his 30-something son not to go near a 99% equities fund?

Investors Behaving Badly

Resnik says risk tolerance doesn’t tend to change, so what happened to the retired banker dad? Well, there is another concept at play and that is behaviour.

Your risk behaviour is influenced by how badly you want to achieve your goals, the perceived risk, the perceived alternatives, the level of trust in an adviser if one is involved, as well as your underlying risk tolerance. Risk behaviour is how you act when you are surprised by an outcome.

So, if the riskiness of a proposition is not explained to you or you were mis-matched with a proposition, you could find yourself getting a nasty surprise.

If you feel you need to refresh your risk profile or even be profiled for the first time, book a call with me.