Risk means different things to different people; it may imply danger or thrill, worry or excitement, opportunity or uncertainty. Establishing how you view risk in relation to your financial goals and investments is a vital part of the planning process.
We believe that risk can be broken down into two key parts:
Risk capacity is, simply, the amount of uncertainty or loss that you, as a client, can accept in order to achieve your goals without adversely impacting your lifestyle or security; it is a measure of “how deep your pockets are”. If a small loss in your investments will have a big impact on your financial well-being, then you have a low risk capacity. If you have a “buffer zone” which will allow you to accept financial uncertainty and ride out the storm then you have a higher risk capacity. Looking at the time horizon of your goals and the initial capital invested will all have a bearing on your risk capacity for each goal.
Risk tolerance is much more to do with the psychological impact of risk; it is the degree of volatility or change that you are prepared to endure with your investments. This is your risk “comfort zone” or the amount of risk you are happy to take and still sleep at night. Risk tolerance will vary depending on age, income needs and individual financial goals. It is all about your specific circumstances.
Understanding these two separate concepts will help us make realistic decisions about your financial goals and the objectives for your investments.
It is important to remember that you can have a different risk capacity and risk tolerance for different financial goals.