Riskin investing is a moot. Risk in investing is often treated as a measurable, objective factor-something that can be quantified, modeled, and managed. Traditional finance teaches us to assess risk through metrics like volatility (standard deviation), beta, or Value at Risk (VaR). Yet, in reality, risk is deeply personal, subjective, and ever-changing. It’s accepted that it varies across individuals. In my experience, I’ve observed that even for the same individual, risk and the risk-taking ability varied with context and time. The core issue is not risk or its assessment but not fully understanding oneself.

Most risk-assessment tools assume that an individual’s risk appetite is stable. Questionnaires ask: “How would you react if your portfolio dropped 20 per cent?” But this is a flawed approach because human psychology doesn’t work in a vacuum. During market booms or euphoric phase, investors feel invincible. Their decisions often go correct and hence begin to add more risk unknowingly chasing high flying stocks or speculative assets believing losses are unlikely or they end up right always. And during bear markets or market crashes, fear takes over. The very investor who’s been making profits through the speculative trades now compounds losses, often selling winners (in the medium term).

Irrespective of the market, if there’s a personal situation or crisis, then the tolerance varies. For instance, if a young professional with stable income may tolerate market volatility, but after a job loss or health crisis, their risk tolerance plumates. This inconsistency show reveals the myth of static risk tolerance and risk isn’t just about numbers but I’s about emotions, biases and personal circumstances.

So, imagining losses and circumstances through a questionnaire doesn’t really throw up the risk profile of an individual. Another distinction to make is the risk capacity versus risk tolerance. While risk tolerance concerns about the willingness to take risk and capacity is the capability to withstand a financial loss. Tolerance shifts with moods, cycles or even on sleep quality but capacity evolves with career changes, income, inheritance or exigencies.

A questionnaire ignores or can’t capture situational variables like job loss or medical emergency. The same tolerance of 20 per cent crash in the market would vanish in such situations. Too much attention to this would involve more emotional decisions than rational. Individuals tend to overestimate their tolerance during good times and rundown during tough times. Risk tolerance is a behavioral aspect and could be altered or trained.

Risk capacity on the other hand is more constructive and objective. It’s measurable, calculable and varies slowly (due to life events). For instance, if an individual at age 50, per the life stage conventional asset allocation, should be having about 50 per cent or less on equity or riskier assets. But, if his goals are sorted, with enough contingency provisions and no dependents then they could as well have allocation to riskier assets upwards of 70 per cent too. If the individual is aware and has participated in earlier market cycles, then they would have a fair understanding of the dynamics and hence could increase the risk tolerance because they’ve sufficient capacity to absorb the losses and possibly the time too.

Risk in investing isn’t just about market movements or associated with a product. They’re like mirrors, reflections of us. Risk profiles aren’t stamped passports, they’re weather systems, shifting with winds and external storms. The greatest portfolio risk isn’t market correction; it’s the delusion that a 10-question form can capture our financial self. The most successful investors aren’t necessarily the ones with the best financial models but those who understand their own psychology, limitations and biases. Before fine-tuning portfolios, we should sharpen our self-awareness. True security comes with ruthless self-examination.

(The author is a partner with “Wealocity Analytics”, a SEBI registered Research Analyst firm and could be reached at [email protected])