Risk tolerance
How much risk an investor or organisation can and will bear in pursuit of its objectives. For a client it combines ability and willingness, and where they disagree the lower usually governs.
Where you will meet it
Risk tolerance appears in 18 learning outcomes on the CFA syllabus. A few of them:
- Set out the parts that make up an investment policy statement
“It sets objectives — return requirement and risk tolerance, which have to be reconciled rather than stated separately — and constraints, conventionally liquidity, time horizon, tax, legal and regulatory position, and any unique circumstances.”
- Set out what makes a sound benchmark and defend the choice of a particular benchmark
“For a bond mandate the key test is fit with the client: the benchmark's duration, credit quality, sector mix and currency should mirror the client's objectives and risk tolerance, and a liability-driven investor's benchmark should resemble its liabilities rather than a broad market index.”
- Explain how relationships, emotions and family systems interact with wealth and the way it is managed
“Family members may differ in their attitudes to money, their risk tolerance and their say in decisions, and events such as a business sale, divorce or a founder's death can shift power and trigger conflict.”
- Set out the strategic issues to weigh when rebalancing an asset allocation
“Considerations include transaction costs and taxes, which argue against frequent trading; the investor's risk tolerance; the volatility and correlation of each asset with the rest of the portfolio; liquidity, since illiquid assets are hard to trade; and beliefs about momentum versus mean reversion.”
Practise it
Practise risk tolerance until it is automatic: questions that explain every wrong option.
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