Assessing risk tolerance is a lifelong conversation

IN THE world of investing, volatility is the norm. Markets rise and fall, and even the most seasoned investors may find themselves gripped by fear in the face of sharp declines.

Many investors say they are comfortable with risk – until the market drops 30 per cent. That is when the real test begins. I have seen this in the course of my nearly three-decade career.

In such moments, whether one stays invested or panics and sells often hinges on something far more personal than market data – one’s personal risk tolerance. The real danger is not market volatility; it’s the mismatch between how much risk you think you can take and how much you can actually live with when things go south.

When a portfolio’s risk level is misaligned with one’s profile, one is more likely to abandon it during market downturns, often locking in losses and derailing long-term goals.

Determining an investor’s true risk profile is a complex exercise and cannot be surmised merely from a multiple-choice questionnaire. It is difficult to get it perfectly correct, but doing it well would ensure that we build suitable portfolios for investors or ourselves.

Purpose of risk profiling

Risk profiling is often misunderstood as a regulatory checkbox or a theoretical exercise. But in truth, it is one of the most critical components in wealth planning. After the initial discovery session, an investor’s ikigai goals, financial situation based on factors including assets, liabilities, income and expenses, need to be reduced to this – a specific of risk appetite.

This is not about avoiding risk, but about taking the right amount of risk – one that is appropriate, intentional and aligned with the investor’s overall plan. Since developing our framework for assessing risk in 2004, we have had many sessions of intense debates over the years on how we can better assess our clients’ risk appetite and construct appropriate portfolios to match them.

Three pillars of risk assessment

When we assess an investor’s risk appetite, we must go beyond a superficial scoring system. True risk assessment involves deeply understanding three key dimensions: need, ability and willingness to take risk. Each one matters, and together they form the basis for determining the appropriate asset allocation.

1. Need to take risk

This is about the return the investor objectively needs to achieve each of his or her goals. For instance, if you have accumulated sufficient assets to meet your desired lifestyle, you may not need as high a return to reach your goal. Taking on more equity exposure (and thus more risk) than necessary exposes you to unnecessary stress and downside.

On the other hand, younger investors with a long runway and ambitious goals may need to take more equity exposure (and thus more risk) to build wealth over time. But even then, need must be balanced with their capacity and comfort with volatility.

2. Ability to take risk

This refers to the objective financial capacity to absorb possible losses in the short term. Factors such as time horizon, income stability, liquidity needs, financial health, insurance coverage adequacy and buffer assets all influence an investor’s ability to endure short-term fluctuations without having to exit the market prematurely.

For example, a 35-year-old professional with a stable income, no dependents, and a long investment horizon may have a high ability to take risk, even if emotionally, they are more conservative. Conversely, a similar person with poor financial health, short time horizon and high liquidity needs would have a low ability to take risk, even if psychologically, they are prepared to take on more.

3. Willingness to take risk

This is the subjective, emotional side of risk tolerance. It reflects how comfortable a person is with market ups and downs. Are they able to sleep at night when markets are falling? How did they react in previous downturns? Do they check their portfolio obsessively or take a long-term view?

In our experience, this is often the hardest to assess. Many investors overestimate their tolerance when markets are calm, only to discover their true limits during turbulent periods. This is where skilled, contextual listening comes in. While risk questionnaires serve a purpose here, they are at best a starting point. Understanding an investor’s stories, fears and financial history provides better insight than any form can. An investor’s investment knowledge also contributes to his willingness to take risk.

Furthermore, a risk questionnaire is static and the answers given tend to be influenced by recent market experiences. An investor might score “aggressive” after a long bull market, only to panic when the next crash arrives.

Advisers must interpret these tools in the context of real-life conversations. A meaningful risk profile emerges from asking the right questions, listening deeply, and understanding the person behind the answers.

Life happens beyond the initial profile

Even the most skilled and thorough risk assessment is not permanent. Life changes, and so should the portfolio. A sudden job loss, the birth of a child, a health diagnosis, or the sale of a business can drastically shift an investor’s need, ability or willingness to take risk. For example, a person might have a high risk tolerance in their 40s, but after a major life event, like the death of a spouse, that tolerance may, understandably, decline.

This is why assessing risk tolerance should never be a one-time exercise. It must be reviewed regularly, not just as a compliance step, but as part of a lifelong conversation in a relationship. A portfolio is not a product to be bought and forgotten, it is a reflection of a person’s evolving life. That means a wealth plan must be a living document that can be tweaked.

The goal of risk profiling must not be to tick a compliance checkbox. It is to ensure the investor’s portfolio is built in a way that supports their life, values and goals, even in times of uncertainty. A portfolio must be one that they can stay invested in and get the returns they need.

This is where a trusted adviser makes the greatest difference – not in predicting the next market move, but in making a judgment call from knowing the person and then adjusting the plan as life unfolds.

Risk profiling, done right, is the quiet cornerstone of a sound investment plan. It is not a formality, but a relationship-building process that honours the complexity and uniqueness of every individual. This is why I believe that technology alone cannot replace good wealth advice.

A well-constructed investment portfolio is not about chasing returns; it is about ensuring the investor can remain invested through thick and thin. To do that, we must start with the right understanding of risk, and what it means to the individual, and how much of it they can and should take. This is a lifelong conversation.

The writer is chief executive officer of Providend, South-east Asia’s first fee-only comprehensive wealth advisory firm