Risk Tolerance/Desire vs Risk Capacity

[00:00:01] Welcome to Business, Finance and Soul. My name is Shaun Enders and I'm a curious entrepreneur. I love exploring business, personal finance and consciousness. I'll jump around topics, offer my opinions and occasionally interview interesting people. Looking forward to going on this journey. Let's be curious together.

[00:00:21] Welcome back to Business, Finance and Soul. I want to ask you, have you ever thought about risk tolerance versus risk capacity? I think today is an important subject to explore because there's an idea that our risk tolerance and our risk capacity are one in the same.

[00:00:51] And they're really not. And that's what today's conversation is going to be focused on. I mean, they can be. They certainly can be. For many people, they might be. For you, they might be. But for others, they might not be. And I think that it's important to go through this exercise and understand why it's so important in life.

[00:01:12] I think when we think about risk, many of us immediately associated with financial investments. But risk isn't just a financial concept. It's really a life concept. Every decision that we make carries some level of risk, whether or not that's switching a career or starting a new relationship.

[00:01:33] Understanding the difference between your risk tolerance and your personal risk capacity should be able to help you make better choices, not just with your finances, which I think is very important. And we're going to talk about that and how you can really use this analysis to help you gain more wealth, gain more comfortability in the accumulation of your investments.

[00:02:01] But also in every other area of life. So let's talk about what is risk tolerance. I mean, really, risk tolerance refers to your emotional comfort with risk. It's your personal willingness to endure uncertainty, volatility, or the possibility of loss.

[00:02:19] You know, some people thrive on high risk scenarios. You know, they're excited by a big win. And other people are more on the stability side, more consistency, more predictability, even if it means, you know, I guess less payoff, you know, smaller rewards.

[00:02:42] I actually think that I noticed this about myself. My brother-in-law has a higher risk tolerance when it comes to gambling. We were in Vegas and I saw him, you know, push a much larger stack out onto the craps table than I could stomach.

[00:03:03] And although financially, I knew that I had the resources to put more, even, you know, on the craps table, even when I saw a good roller, somebody's, you know, rolling numbers and, you know, the excitement, everything.

[00:03:21] But in my mind, I'm going, I could lose. And I work hard to gain this money. So I knew at that moment, my risk tolerance right there, it's not low. I mean, I've started a business.

[00:03:36] I invest into different financial instruments, including properties and companies. But I know that I have to feel a certain way in order to push chips out on the table.

[00:03:50] I know I have to feel a certain way to increase my bet. And so my risk tolerance is lower than his in that instance.

[00:04:00] Doesn't mean across all things. It just means in that instance and knowing yourself and knowing what is risk tolerance and why is it so important.

[00:04:09] It's going to it's going to help you get a baseline for yourself.

[00:04:14] You know, risk tolerance is really shaped by your personality, your experiences.

[00:04:19] You just your individual emotions. And it's just why some people will ride out a volatile stock market crash while others panic sell.

[00:04:33] I experienced this where the last market dip. It wasn't even a dip. I mean, it was it was extreme volatility post covid right before things really went on a good bull run.

[00:04:47] But, you know, market was melting down based on this uncertainty. And I remember talking with a friend and he was selling everything.

[00:04:55] I was just not good. You know, in that instance, what's really interesting is I knew my risk tolerance was higher than his.

[00:05:04] So that was very apparent for me. I tried to talk him out of it, but that wasn't going to happen.

[00:05:10] You know, in that in that moment, it was very easy to identify that his risk tolerance was really low and he was he was living more in kind of a fear based mindset.

[00:05:22] What can you do? That's just where he was at.

[00:05:26] So it's not just about the emotions.

[00:05:32] It's it's it's it's a culmination of all of this.

[00:05:36] And people with high risk tolerance might be more willing to start a business or make a career shift or try something completely unconventional.

[00:05:44] The two are tied. So.

[00:05:46] So. Let's talk about risk capacity.

[00:05:49] Risk capacity is more of your financial and emotional ability to withstand loss.

[00:05:55] And this is different because risk tolerance is all about what you're willing to do.

[00:06:00] Risk capacity is what you're able to do.

[00:06:04] And I think that this is an important distinction that that we need to discuss.

[00:06:09] Yes. Elon Musk is a prime example of, you know, his ability to have a high risk tolerance.

[00:06:18] He's willing to take a bold big game changing moves.

[00:06:21] But here's the deal.

[00:06:23] He also has the financial capacity to handle significant losses.

[00:06:28] If one of his ventures struggles, he has the wealth to sustain the setback and move forward.

[00:06:35] What's interesting, he didn't always have it at this level.

[00:06:39] I mean, there was certain there's certainly a time where his risk capacity was lower, even though he had millions from some of his initial exits from businesses.

[00:06:50] He put those he made large bets and put those millions on the table for both Tesla and SpaceX.

[00:06:59] And so that's a prime example of where his risk capacity, although it was high, his risk tolerance was actually higher.

[00:07:10] And that allowed him to say, OK, my capacity will will take me only so far.

[00:07:16] And then my tolerance has to kick in because I'm going to need to even go bigger than what I have.

[00:07:22] And that's that's very, very interesting.

[00:07:26] You know, the ability to endure loss.

[00:07:34] That's really it.

[00:07:35] That's the risk capacity.

[00:07:36] And for most people, risk capacity, it's determined by the financial resources.

[00:07:40] It's determined by your support system.

[00:07:44] It's determined by your own mental resilience.

[00:07:48] But here's the catch.

[00:07:50] It's possible to have a high risk tolerance, but a low risk capacity.

[00:07:55] So this is what's really interesting.

[00:07:58] Imagine someone who's comfortable with the idea of quitting their job to start a business.

[00:08:04] You're emotionally ready for that challenge.

[00:08:07] But you only have one month's worth of savings.

[00:08:11] Your risk capacity, super low.

[00:08:13] On the flip side, someone with a large financial cushion may have a high risk capacity.

[00:08:19] They've got all the money in the bank.

[00:08:22] Their 401ks look great, but they're just really uncomfortable with what they perceive as a big risky move.

[00:08:31] Low risk tolerance.

[00:08:33] So why does it matter?

[00:08:36] What difference does it make?

[00:08:38] In our lives, it's important to understand where and how these, I would say, very real triggers come from.

[00:08:55] Because the more we understand about ourselves, the more we understand about how we move, who we are, the easier it is to make decisions.

[00:09:06] Knowing the difference between risk tolerance and risk capacity, it's crucial because it reveals what I consider a personal risk axis.

[00:09:16] If you have a personal risk axis, you're going to figure out where that intersects.

[00:09:26] And you'll be able to get involved in investments that make sense for you.

[00:09:33] You'll be able to increase really your acumen into instruments that can create bigger wealth for you.

[00:09:43] Or you'll just set your goals.

[00:09:46] You'll set your investment strategy.

[00:09:50] And then you'll just let it go.

[00:09:52] You just won't get so involved because you just don't want to see it.

[00:09:57] You have kind of a low risk tolerance.

[00:09:59] You don't want to know about it.

[00:10:00] You just, I want to know I'm doing the right thing.

[00:10:02] Here I go.

[00:10:05] So firstly, let's just start with financial investments.

[00:10:09] Because if we're talking about the world of investing,

[00:10:18] a lot of people will go, okay, I'm okay with risk.

[00:10:22] So I'm going to invest in aggressive stocks.

[00:10:24] But when the markets dip, that's when that panic sets in.

[00:10:30] That's not failure of risk tolerance.

[00:10:32] It's a mismatch with risk capacity.

[00:10:35] If you don't have the capacity to endure the financial loss over a long timeline to recover,

[00:10:41] it's better to pursue kind of a less volatile investment.

[00:10:44] For instance, anytime somebody says, hey, should I invest into this mutual fund or this ETF or this particular stock?

[00:10:57] My answer right off the bat or my question back is, what's your timeline?

[00:11:02] Because if it's one year or two years, guess what?

[00:11:09] I don't know if your tolerance and capacity are going to line up because you need that money.

[00:11:15] You need that capital.

[00:11:16] And so your capacity is much shorter because you're going to need that money.

[00:11:22] But if you say, hey, it's 10 years.

[00:11:24] The horizon is 10 years.

[00:11:26] Great.

[00:11:27] Absolutely.

[00:11:28] Absolutely.

[00:11:28] Let's look at the investment closer because you'll be able to withstand the losses.

[00:11:33] Although they'll just be on paper.

[00:11:35] I mean, you'll have to you'll look at it and go, OK, you can withstand losses.

[00:11:41] You don't have to sell.

[00:11:42] So it's not a real loss.

[00:11:44] And now you've just got to play with your tolerance, which is it's it's dipped.

[00:11:48] You've lost money on paper.

[00:11:50] It's OK.

[00:11:51] Don't panic sell.

[00:11:52] Keep writing because remember, you're going 10 years out and we're only two years in and there's a dip.

[00:11:57] There's a pullback.

[00:11:58] So I do think that this is why you really, really want to make this analysis and you want to look at time horizon when we're talking about your financial investments.

[00:12:10] For career moves, if you're considering quitting a stable job to pursue maybe a startup, it's easy to romanticize the risk taker narrative.

[00:12:21] But before you take the leap, just ask yourself, do I have the financial resources to support myself if this doesn't work?

[00:12:29] I know that seems obvious, but that's the first question.

[00:12:34] Do the math.

[00:12:35] What's my runway?

[00:12:37] Next question.

[00:12:38] Do I have the mental and emotional stamina to handle the setback?

[00:12:44] Because.

[00:12:46] Just having a high risk tolerance doesn't guarantee success if your risk capacity is low.

[00:12:52] So you really have to be able to say, yeah, I've got the mental and emotional stamina.

[00:12:56] What are you going to do?

[00:12:57] You have a setback.

[00:12:58] What do you do?

[00:13:00] That's my question to you.

[00:13:01] Well, you know what?

[00:13:03] I talk with trusted advisors.

[00:13:06] I meditate.

[00:13:08] I journal.

[00:13:09] I do something to make sure that I look at what the purpose of this career move was.

[00:13:18] Meaning I knew it was going to be risky.

[00:13:21] That's okay.

[00:13:23] Let myself move through that emotion and remind my now current self what my former planning self was thinking.

[00:13:34] You know, like, what was I thinking?

[00:13:35] Why did I do this?

[00:13:36] Well, there is a reason you made that decision at that time.

[00:13:39] And honor that.

[00:13:41] Let it move.

[00:13:42] Let it play out.

[00:13:44] Number three, life decisions.

[00:13:46] Because when we're looking outside of money and a career, the idea of risk tolerance versus capacity, it still shows up.

[00:13:56] Relationships.

[00:13:57] Okay.

[00:13:58] We're taking a chance on love can feel risky.

[00:14:01] It's really interesting.

[00:14:03] I mean, depending on how you were raised and what you were surrounded by growing up,

[00:14:09] sometimes, you know, just even falling in love with somebody doesn't feel right.

[00:14:16] It feels too risky.

[00:14:17] Getting out of a bad divorce or a broken relationship.

[00:14:22] Taking a chance on getting into a relationship with someone new.

[00:14:27] Yeah.

[00:14:29] Massive amount of risk to you personally.

[00:14:32] So some people have that emotional capacity to be vulnerable.

[00:14:36] You can endure heartbreak.

[00:14:40] They can go from one relationship to the next.

[00:14:43] We've seen those people.

[00:14:44] You might be friends with individuals.

[00:14:45] You might be that person where you're like, hey, it doesn't matter to me.

[00:14:49] I'm okay.

[00:14:51] And others might really struggle to recover from rejection.

[00:14:56] And the same applies to parenting, to moving to a new city, to making a big lifestyle change.

[00:15:03] So you'll see that risk capacity and risk tolerance, it comes up in all areas of our life.

[00:15:09] And that's why it is really important to have this discussion with yourself.

[00:15:14] Because there's this, you know, mentality and this idea that we have to go through, which is short-term pain versus long-term gain.

[00:15:23] We've heard it, but what does it mean?

[00:15:25] Because at the heart of risk is one big question.

[00:15:29] Are you willing to endure the short-term pain for the possibility of longer-term gain?

[00:15:36] If you're investing in the market, this means weathering downturns in order to benefit from long-term growth.

[00:15:44] If you're launching a business, it's about pushing through the lean years to reach sustainable success.

[00:15:50] I've mentioned before, this year was a harder year for us as a business financially.

[00:15:57] It was a massive amount of personal resiliency to push through.

[00:16:04] Because we've been around for 19 years.

[00:16:06] We've had so many unbelievable years.

[00:16:09] I have a long-term mindset.

[00:16:13] So short-term setbacks, not fun, not cool.

[00:16:18] So I don't love having to go through it, but I have to remove myself from the moment and say,

[00:16:26] okay, well, but what am I gaining here?

[00:16:29] You know, what is it?

[00:16:31] What's the upside on the long-term?

[00:16:34] But not every risk is worth it.

[00:16:36] If your risk tolerance is low, then you'll find the pain of risk,

[00:16:41] the quote-unquote pain of risk, completely overwhelming.

[00:16:45] If your risk capacity is low, taking a risk could jeopardize both your financial and emotional well-being.

[00:16:53] So you want to know where you stand because you can strengthen it.

[00:16:56] You can strengthen your risk capacity on the investment side, right?

[00:17:02] By saying, okay, well, before I move into this, let me make sure that I build this amount of runway financially.

[00:17:11] That's a higher capacity.

[00:17:14] You know, that is tangibly something that I can work on.

[00:17:18] Same thing in relationships.

[00:17:20] You know, before I get into my next relationship, I'm going to go do personal counseling.

[00:17:26] I'm going to increase my capacity.

[00:17:29] So when I decide I want to do something, my tolerance, I have a greater capacity because I've done the work.

[00:17:37] So it's kind of cool that both are malleable, but you've got to know your own personal risk access.

[00:17:47] I say access, but it's really, you know, what is the center point for you?

[00:17:58] So how do you assess your risk access?

[00:18:04] First, check your risk tolerance.

[00:18:07] Ask yourself, how do I feel when things are unpredictable?

[00:18:12] Do I see it as more of an adventure or as a threat?

[00:18:16] That's a good one for me because if it's an adventure, and I say this when I'm not in the middle of it, right?

[00:18:24] I say this when I'm calm, cool, collected, and aspirational.

[00:18:29] That way I have something to go back on.

[00:18:32] I can look at it and go, okay, remember, this is an adventure, okay?

[00:18:37] This isn't a threat.

[00:18:38] I'm okay.

[00:18:39] I wanted this.

[00:18:42] Reflect on some past decisions because when you're faced with uncertainty, you look at this and go, did I lean in or did I back away?

[00:18:53] So that's number one.

[00:18:54] Check your risk tolerance.

[00:18:56] Ask yourself a couple questions here.

[00:18:58] Look at your past decisions on, you know, who are you?

[00:19:02] Number two, check your risk capacity.

[00:19:04] That's really on the financial side.

[00:19:07] Look at your financials.

[00:19:08] Do you have the cash reserves to handle the loss?

[00:19:11] You know, if you invest into a business and you put $200,000 down into a company or a startup or something like that and you lost half of it in the next six months.

[00:19:23] You okay?

[00:19:25] You know, can you pay your bills?

[00:19:27] Or was that all the money you had?

[00:19:29] Because if you're fine, your risk capacity is okay, you can ride it out.

[00:19:35] So you've got to make that assessment.

[00:19:38] You've got to know where you are.

[00:19:39] And it's okay wherever you are, but just know what it is.

[00:19:43] Really the second within checking your risk capacity is considering emotional support.

[00:19:48] You know, do you have the people in your life who can provide the emotional and practical support?

[00:19:53] As I meet with other business leaders and CEOs, we can lean on each other during tough times of where, you know, the runway that we thought was fine for risk capacity.

[00:20:07] All of a sudden, it's much shorter because we're investing more heavily into something that isn't paying off like we expected.

[00:20:17] So now our risk capacity is getting shorter and shorter and shorter.

[00:20:21] This is kind of like what I was talking about with Elon when he was launching SpaceX.

[00:20:24] And essentially by his third rocket launch was out of cash and it had to go well.

[00:20:31] But he went all in on found additional resources, shortened his launch time from six months to six weeks because they were running out of money for a fourth rocket launch.

[00:20:43] And well, rest is history.

[00:20:45] And we know where SpaceX is now.

[00:20:47] But that runway shortened from where his initial analysis was on risk capacity.

[00:20:54] So check yours, but be sure to understand that you're going to make adjustments at times.

[00:21:00] And then number three on your assessment is making a plan for risky decisions.

[00:21:07] Because if you're low on risk capacity, but high on tolerance, plan a way to boost your capacity.

[00:21:15] Figure it out.

[00:21:16] Make that a focal point.

[00:21:19] And I think that that becomes really cool.

[00:21:21] It becomes something that you can go after because you're like, hey, I kind of want to go in on crypto.

[00:21:29] Right.

[00:21:30] I've made that decision.

[00:21:31] I have invested into crypto.

[00:21:34] It's actually a great story because I've invested in two different ways.

[00:21:38] The first one, my risk capacity was fine.

[00:21:42] My risk tolerance wasn't.

[00:21:44] It was so weird because it was so volatile.

[00:21:46] It was like unlike any other investment I had gotten into.

[00:21:49] And so as I was investing into both Bitcoin and Ether, five, six years ago, it was really, really choppy waters.

[00:22:06] And I was buying and selling.

[00:22:08] And so I did not have just the believer mindset.

[00:22:13] When I took a second bite of the apple and came back, I retooled and said, hey, listen, Sean, your commitment to yourself is long term on this.

[00:22:26] You have to set your horizon out further than what you're trying to do, because this is a different type of financial vehicle.

[00:22:35] Right.

[00:22:36] This is an alternative investment that you can't just look at and set trade, you know, on a daily or monthly basis.

[00:22:43] So I set my horizon out to more of a decade.

[00:22:49] And thankfully, I did that because, you know, where I invested, then there was a pullback and then, you know, major upward trajectory.

[00:22:58] And again, on paper, it looks good.

[00:23:03] We'll never I don't know where it's going to be.

[00:23:05] I don't plan on doing anything until I reevaluate a 10 year horizon.

[00:23:11] I said a decade.

[00:23:12] So that was again, that was another plan for a risky decision on investment to say.

[00:23:20] I got to get my game plan together and I got to figure this out, because if I maintain a low risk tolerance, this isn't going to be an investment that I want to be part of.

[00:23:30] And so I had to make that decision.

[00:23:32] And so you may be in that same spot where you say, I don't normally act this way, but.

[00:23:38] On this, I believe.

[00:23:40] And so I'm setting a new timeline.

[00:23:42] I'm creating rules around this investment.

[00:23:45] And that could be, like I said, an alternative investment.

[00:23:48] That could be real estate doing a, you know, flip or, you know, saying, OK, well, I'm going to get into multifamily or syndication or, you know, could be anything.

[00:24:01] Could be on personal residence.

[00:24:03] But you have to make the assessment for where you are.

[00:24:06] It's not across the board.

[00:24:09] And, you know, this is a personal decision of risk because not everyone is is wired to chase the thrill of risk.

[00:24:19] And that's OK.

[00:24:20] We don't want that.

[00:24:22] You know, a person with high capacity but low tolerance might choose steady investments over risky ventures.

[00:24:27] It's valid.

[00:24:28] It's a personal decision.

[00:24:30] But it's a plan.

[00:24:31] And that's what's key.

[00:24:33] You know, if you're if you're bold on action, but you're lacking the capacity to endure the loss, you're not wrong for feeling comfortable.

[00:24:43] But it is a sign to pause, plan and build your capacity.

[00:24:47] So I think understanding where you sit within this personal axis of risk tolerance and capacity will change the way that you approach all major decisions in your life.

[00:25:01] You know, because it's not just about being brave or bold.

[00:25:05] It's about being wise.

[00:25:07] And how do we gain wisdom?

[00:25:10] Intentionality and sometimes just time and learning.

[00:25:13] But knowing yourself, knowing your resources, knowing your goals is going to allow you to pursue more of the long term gain over that short term pain that we were that we were thinking about.

[00:25:25] And so, you know, whether or not this is a time in your life where you're thinking about investments, you're thinking about either career change, a big life move, starting a business.

[00:25:37] You just ask yourself, do I have the tolerance for this risk?

[00:25:41] Do I have the capacity to handle things if they go wrong?

[00:25:46] And when your answer is yes to both, you're not just taking a risk.

[00:25:51] You're making a strategic, thoughtful decision.

[00:25:55] And that's where I like to live.

[00:25:59] So I hope you find this valuable as you're planning for 2025.

[00:26:04] You're thinking about, you know, what next chapter lies ahead for you.

[00:26:11] And as always, I hope you stay curious.