Risk Capacity

Accounting for an investor's time horizon needs a rethink now that investments are no longer closely tied to singular investment objectives.

Most attempts to measure risk tolerance fail in at least one crucial way, be it confusing the measurement, confusing the audience, or thinking guesswork is a good enough replacement for rigorous psychometric science.

Increased complexity is a cost that the new benefits need to justify. What are the costs and benefits of your cost-benefit analysis? Too often, cashflow modelling introduces additional costs for little to no additional benefit.

If you start with high risk capacity, then after a fall in the markets your capacity gets even higher. If you start with low capacity, then lower market values means an even lower capacity.

Risk is not about the journey; it's about where you could end up. It is the risk of money not being there when it's needed, reflecting both the chance and the severity of poor returns.

A focus on the boxes to be ticked rather than the reasons the boxes exist can lead to laws being followed at the expense of meeting the very outputs the laws are there to produce.

If the risk that you're willing and able to take is not enough to get you to your goals, then any use of 'risk required' implies taking more risk than you're either able or willing to do.

Linking investor and investment risk requires putting the two into the same language; common approaches to doing this are not fit for purpose.There cannot be a perfect empirical way of mapping investor risk to investment risk.

Valid and reliable measures of risk tolerance and the short-term behaviours investors exhibit in seeking emotional comfort with the investment journey both have crucial roles to play in a risk-profiling process.

Risk appetite questionnaires need not be (indeed, should not be) elaborate. Over-engineered and superficially sophisticated 'revealed preference' approaches result in exactly the same problem for investors as Kids do for investments:

Profiling outputs should not be set to match the 7-point scale used in KIIDs. There is little point to profiling investors with more granularity than you can provide solutions for;