By Caroline Grimont
A friend of mine is absolutely terrified of driving. First, she was scared of driving at all, then she got her G2 and realized what a time saver a car can be. For the past couple of years, she has been driving along smaller roads, she leaves for road trips hours before the rest of us so she can putter along slowly while the rest of us regular folks take the expressways. But now, she has to take her G-test, which means she needs to get on the expressway. She’s been stalling for months, but she did her first drive – on Toronto’s notorious Gardiner, of all things – last week.
I asked her how she did it, and she said, ‘I controlled as many variables as I could.’ I asked her to explain, and she told me that she got a reliable instructor with whom she felt safe, she asked him to use his car (which is a 2024 model hybrid with all the bells and whistles, including lane indicators, and most importantly, has brakes and accelerators on the passenger side as well,) and started her lesson at 7:00 a.m. and ended at 9:00 a.m. so she got the experience of no traffic and full traffic. And then, ‘The only thing that was left to chance was other bad drivers, and I can’t really control for that, can I?’
This got me thinking about investing. What my friend did was, in her words, controlling variables, but from an investment standpoint, what she was doing was mitigating risks. Though others might disagree, in my opinion, understanding and managing risk is the most critical competent of investing. Let’s try and understand risk a little more.
What is Risk? How is Risk Measured?
Risk generally is understood as the chance that something bad might happen. You might think that investment risk means a chance that your investment might go down, but that’s not the whole picture. In investing, risk usually means the variability, or uncertainty, in the actual returns you get, versus what you expect.
This variability – on either the higher or lower side – is assessed and measured in a number of ways, the most common of which is Standard Deviation. Standard deviation measures, on average, by how much individual data points deviate from the mean. Simply put, it helps investors understand how much their returns might swing in one direction or another. (Standard deviation has a few critics for a variety of reasons – for one, it does not differentiate between upside or gains, and downside, or losses, and for another, it does not take into account other factors like income stability. But that is a discussion for another column!)
Could that stock that you own fall by 60%? Its historical standard deviation might be able to offer some clues. But does that question itself cause you anxiety? If it does, it could mean that you need to examine how much risk you are comfortable taking.
Risk Capacity Vs Risk Tolerance
Risk is very personal. What I think is risky is likely not what you think is risky. That friend of mine who is scared to drive? 99% of her investment portfolio is in equity markets. That’s very different from my portfolio.
This is why, it is critical for investors to understand their risk capacity and their risk tolerance. The Canadian Investment Regulatory Organization (CIRO) defines the two like this:
- Risk Tolerance: Risk tolerance captures your willingness to take on risk and to deal with uncertainty. Risk tolerance is a subjective meaning that is very specific to you, your preferences and comfort level.
- Risk capacity: Risk capacity is your objective ability to take on financial risk. Your risk capacity depends on factors specific to you and your family such as your income, savings, employment status, age, debt levels, health status, etc.
The Ontario Securities Commission’s (OSC) investor education site asks, ‘Risk tolerance involves thinking about two questions: 1. How much risk are you able to handle? How much risk are you willing to handle?’
You may want to be able to buy all the cryptocurrencies out there, and grit your teeth and HODL during the wild swings the asset class sees, but can you? It is critical that you know the answers to these questions, because that can form the basis of your investment life.
The OSC phrases it like this, ‘Would you be okay financially if you lost more than expected in a risky investment? Or would an unexpected investment loss force you to reduce your standard of living? Your answer will help you understand how much risk you can handle, financially. Your willingness to tolerate risk introduces the emotional side of investing. It is also called your psychological risk tolerance.’
How Do I Know How Much Risk I Can Take?
Investors have to consider a number of factors that go into their risk assessments, including their financial goals, comfort during downturns, life stages, previous experience with risk, investment knowledge, and many other factors. There are several online questionnaires that can help with this, such as this one from the Government of Canada, or this one from CIRO.
But how much risk is risk, really? Consider this. Almost all of these situations involve some risk:
- There is an added currency risk with any international investment, of course, but with all the hoopla around tariffs, the loonie is weaker than it once was against the U.S. dollar. So now, if you buy U.S. stocks, or ETFs, you have to weigh that potential downside volatility into your calculations as well.
- The Magnificent Seven stocks have gone from having King Midas’s touch last year, to ‘struggling’ in 2025. Are these stocks ‘risky?’ Yes, and no. Stocks, in general, are riskier than bonds, but there are risky stocks, and not-as-risky stocks.
- General tech-focused ETFs may be considered high-risk, but many of the Magnificent Seven stocks like Meta, or Amazon, or Microsoft, have competitive advantages that would take other companies a lot of time and skill to breach, giving them some insulation, or what Warren Buffett calls an ‘economic moat.’ This competitive advantage, to some extent, reduces some risk. Investors who want access to a large group of market leaders could consider investing in an exchange traded fund that invests solely in brand leaders, like HBF.
- And then there’s alternative asset classes. The risk levels vary wildly there, from relatively stable asset classes like Real Estate Investment Trusts, or REITS (HGR, as an example) to cryptocurrencies, fine art, and even NFTs, which went from $2.8 billion in monthly trading volume to a majority being worthless.
Research has found risk tolerance is a psychological trait, and thus relatively stable over time. But here’s the truth. All investments – whether they offer exposure to ultra safe, Government of Canada treasury bills like TBIL, or the recently launched product that invests in ‘alien technology and UFOs’ – have risk. Which is why it is very important to know how much risk you, personally, are willing and able to take.
What Impacts Risk Tolerance and Capacity?
As seen with my equity-happy, driving-averse friend, risk is deeply personal. However, there are some factors that impact one’s ability to take risks. Here are a few:
- Wealth – If you have accumulated a lot of money, you might be more willing to part with some of it and might have a greater ability to withstand market downturns. If, however, you need an emergency fund buffer, you might be less willing to risk all of that on a hot tip.
- Time – Compound interest is your friend. If you are a new graduate, saving $50 a month may not seem like a lot, but by the time you retire, it could grow to a tidy nest egg. On the other hand, if you’re deep into retirement, you might not be able to afford the luxury of time in the market, and so you might be less able to take large risks.
- Experience – If you lost a large chunk of money in 2008, or in the market corrections around the time of the COVID-19 pandemic, you might be more fearful. If you made a lot of money around that time, you might have an unrealistic expectation of higher returns.
- Life Events – If you earn a higher paying job, or lose a well-paying job, if you have a child, or if you lose a bread-winning partner, all these life events could change how much risk one is willing to take.
How to Manage Risk?
Let’s use my friend’s experience and plan as a starting point for some investment related understanding.
- First, she got an instructor she liked – that could be like getting a financial advisor whom you trust.
- Second, she got a car in which she felt safe – how different is that from picking an investment vehicle that works for you?
- Third, she tried out different times – diversification, the only free lunch in investing.
This is not a comprehensive list. Your circumstances are certainly different to the ones mentioned here, so your ability to absorb risk would be different to what we have outlined. It is important to do your own research, and find a solution that works best for you!
Disclaimer
Commissions, management fees and expenses all may be associated with investing in Harvest Exchange Traded Funds (managed by Harvest Portfolios Group Inc.) Please read the relevant prospectus before investing. This article is meant to provide general information for educational purposes. Any security or investment mentioned herein is for illustration purposes and should not be taken as an invitation to purchase or sell such security or investment. The content of this article should not be construed as investment advice. Tax, investment and all other decisions should be made with guidance from a qualified professional.
