The Next Generation of Risk Measurement Methodology

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Having an accurate investor risk profile is the first step in wealth management. But what is in a risk profile? Is it the same as risk tolerance or is there more to it?

The release of Orion’s 3D Risk Profile and a webinar by Michael Kitces titled “Rethinking Risk Tolerance” got people thinking.

Many of us are familiar with risk tolerance. Also known as the risk attitude, risk appetite, or risk preference, it indicates how much risk the investor wants to take. This is a personality trait.

People also talk a lot about risk capacity, i.e. how much risk the investor can afford to take, which is usually determined by the investment time horizon, the asset level and cash-flow considerations. For example, a retirement account with a 20-year investment horizon can afford to take on more risk because it has time to recover from a downturn.

But what else is in the investor risk profile?

Dr. Daniel Crosby, the mastermind behind Orion’s 3D Risk Profile, says risk composure is the third dimension, indicating how likely the investor stays composed during market turmoil instead of making irrational investment decisions. Risk composure is not a new concept. Michael Kitces wrote about it in this blog post in 2017, but Crosby is perhaps the first person to formally introduce it as one of the dimensions in a 3D risk profile framework, along with risk tolerance and risk capacity.