Risk Tolerance is Not a Feeling
How Investors Can Answer Better Questions Than the Industry is Asking
Executive Summary
“Risk tolerance” (aka, “risk appetite”) is one of the most frequently invoked - and least understood - ideas in investing. Platforms reduce it to a questionnaire. Advisors formalize it into compliance artifacts. Regulators define it as a blend of willingness and ability, then quietly blur the two.
The result is a concept that feels precise but behaves like weather: fair in good markets, foul in bad ones, and unreliable when you need it most.
This article argues that self-assessed risk tolerance is a losing battle. Comfort is cyclical, memory is short, and incentives distort judgment. A more durable framework replaces “tolerance” with five concrete inputs:
Risk Aversion (the reality of loss, not your feelings about it)
Need to Bear Risk
Capacity to Bear Risk
Objectives
Time Horizon
Together, these form a risk strategy, not a mood.
How the Market Sells Risk Tolerance
Platforms, FinTech, and the Illusion of Precision
Most online platforms treat risk tolerance as a sorting mechanism. You answer a short survey: some combination of hypothetical losses, timeframes, and emotional prompts. And then you are slotted into a prebuilt allocation.
This approach is tidy, scalable, and deeply flawed. Why?
It assumes stable preferences.
Investors do not possess fixed risk personalities. They oscillate with markets, headlines, and recent experience.
It substitutes behavior with intention.
Saying “I can tolerate a 20% loss” is not the same as living through one.
It ignores consequence.
Losing 20% means very different things depending on where you are in life and what that capital is meant to do.
In short, platforms use risk tolerance as a label, not a constraint. It simplifies onboarding, not decision-making.
How RIAs Typically View Risk Tolerance
Compliance First, Client Second?
Registered Investment Advisors generally approach risk tolerance through a fiduciary and regulatory lens. FINRA’s guidance, defining it as “the investment risk you are willing and able to accept”, anchors the process.
In practice, this means:
A formal risk questionnaire
Documentation of “client comfort”
Portfolio construction aligned to that stated tolerance
Periodic reaffirmation (often perfunctory)
This framework exists primarily to demonstrate process, not insight. It answers the question: Did the advisor ask? rather than Was the portfolio appropriate?
To be fair, many advisors do more. They layer in experience, conversation, and judgment. But the core artifact - the tolerance score - remains the foundation for many RIAs.
The Core Problem: Tolerance Is Not Observable
Comfort Is a Trailing Indicator
Comfort with risk is not a fixed attribute; it is cyclical, reactive, and deeply influenced by recent experience.
FINRA’s definition collapses under inspection.
How does one measure “ability” to take risk?
Is it income? Net worth? Age? Liquidity? Psychological resilience? Some mixture of all five?
When is an investor capable of unbiased self-assessment?
In bull markets, confidence masquerades as courage. In drawdowns, fear dresses up as prudence.
Risk tolerance, as commonly assessed, is pro-cyclical. It expands at market peaks and contracts at precisely the wrong moment.
This makes it worse than useless; it becomes misleading.
Why Assessing Your Own Risk Tolerance Is a Losing Battle
Investors are asked to predict their future emotional state under stress; something at which humans are notoriously bad. It is near impossible to become unbiased about ourselves.
Three structural flaws doom the exercise:
Recency bias dominates perception
Hypotheticals lack consequence
Language is imprecise (“moderate,” “aggressive,” “comfortable”)
The industry keeps asking investors how they feel about risk when it should be asking how risk functions in their lives.
A Better Framework: From Tolerance to Strategy
Risk tolerance should not be inferred from emotion. It should be derived from circumstance.
1. Risk Aversion (The Reality of Risk)
Risk is not volatility! In plain terms, volatility measures how much and how quickly prices move, not whether those movements are good or bad.
Volatility is direction-agnostic. Sharp gains and sharp losses both increase volatility.
It is typically quantified statistically, most often as the standard deviation of returns over a given period.
High volatility implies uncertainty and variability, not inevitability of loss.
Low volatility implies stability, not safety.
Risk is the permanent impairment of capital relative to need. Losses matter because of what they prevent you from doing.
Put succinctly: Volatility is motion. Risk is consequence.
Acknowledging this reframes the conversation from charts to consequences.
2. Need to Bear Risk
How much return is required to meet your objectives? This is a measurable variable.
If your goals demand growth beyond what “safe assets” can deliver, you must bear risk - whether you like it or not. This is not a preference; it is arithmetic.
3. Capacity to Bear Risk
Capacity is objective and observable. It includes:
Time until capital is needed
Flexibility of spending
Stability of income
Size of surplus relative to goals
An investor with high capacity to bear risk can endure volatility without derailment. One without it cannot, regardless of stated tolerance.
4. Objectives
Capital without clearly defined purpose invites confusion and chaos.
Is the money meant to:
Fund consumption?
Preserve purchasing power?
Transfer wealth?
Buy optionality?
Different objectives demand different exposures.
Risk only exists in relation to purpose.
5. Time Horizon
Time is the great solvent of volatility - but only if it is real.
Stated horizons (“long-term”) often collapse under life events, policy changes, or fear. Effective risk strategy distinguishes between theoretical and usable time.
Furthermore, one’s “horizon” should not only be specific (e.g., 30 years), but take into account the horizon of those who may benefit from the funds (i.e., inheritors).
Debunking the Status Quo
The typical onboarding process treats risk tolerance as an input. In reality, it is an output - the emergent result of constraints, needs, and timelines.
When advisors anchor portfolios to questionnaires rather than circumstances, they outsource judgment to forms and call it fiduciary care.
True fiduciary alignment demands something harder:
Explaining trade-offs
Constraining choice
Designing portfolios that investors can stick with, not merely agree to
Practical Takeaways
Stop asking “How much risk am I comfortable with?”
Start asking:
What must this capital accomplish?
What happens if it fails?
What risks are unavoidable and which are elective?
Risk tolerance is not a personality trait. It is a byproduct of design.
Markets are indifferent to our comfort. They respond only to exposure, timing, and endurance. The task of investing is not to feel at ease, but to remain solvent, flexible, and aligned long enough for time and discipline to do their work.
Design for that and tolerance will take care of itself.
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“That’s Not My Business”
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