RISK. Risk as defined by Webster is the possibility of loss or injury. Well, in the investment world it wouldn’t be defined as injury – but definitely associated with loss. If you add the word tolerance to it, then it would be better defined as; what is the loss you are willing to accept. So, what amount of loss are you willing to accept in the market place, WHAT IS YOUR RISK TOLERANCE? It is a tough question for most people to answer when just simply asked like this.
At Claris we believe risk tolerance is where a person’s investment policy statement (IPS) begins. Your risk tolerance is a unique balance between your willingness, ability and need to accept market risk. We need to make sure we ask this question three different ways:
- WILLINGNESS – How will a downturn in the markets affect you in changing your investment plan? How much do volatile or severe markets scare you?
- ABILITY – How long is your time horizon for investing in this portfolio? Do you have more immediate needs for this money?
- NEED – How much market risk do you need to take to reach your desired goals and objectives?
I believe if we ask the question like this, it becomes more apparent to a client how to answer. Once we have the answers we should have the framework for an IPS and the understanding for the allocation of the assets.
The one thing you should remember, there is no right answer for everyone only one right answer for you!