Risk tolerance is how emotionally comfortable a person is with taking financial risk. For example, how much a person is willing for their portfolio to diminish for a chance to make bigger returns. It is psychological and is best measured with a psychometric tool.
By knowing how comfortable a client is with investment ups and downs, advisors can make sure their clients don’t panic, or worse, blame the advisor when a risk is realised.
Risk profiling is a process for finding the optimal level of investment risk for your client by balancing their risk required, risk capacity and their individual risk tolerance.