Risk tolerance affects how psychologically receptive an individual is to decisions involving risk. Thus, decision-making theory is a good place to seek a meaning for risk tolerance.

Broadly, risk tolerance can be seen as the sum of all the 'fear/greed' trade-offs available, including trade-offs between making the most of opportunities and securing financial well-being, between regret avoidance over 'losses' incurred from taking too much risk, and over 'gains' missed through not taking enough risk, and so on.

Therefore, risk tolerance is best defined as the extent to which a person chooses to risk experiencing a less favourable outcome in the pursuit of a more favourable outcome.

It is important to recognize that risk tolerance represents a trade-off on the continuum from minimizing unfavourable outcomes to maximizing favourable outcomes, not just an upper limit on unfavourable outcomes. "Risk preference" would perhaps be a better label for the attribute being described because "tolerance" has implications that risk is always an undiluted negative. However, "risk tolerance" is the term most commonly used.

Most people accept the universal truth of "nothing ventured, nothing gained." Risk tolerance is simply a question of where each individual is psychologically comfortable in setting the balance point.

Financial advisors should assess a client's financial risk tolerance as part of the planning process. It is an ethical and lawful obligation (see S.92 of the Capital Market and Services Act of 2007).

An added advantage with financial risk tolerance testing is the professionalism attached to it. Financial advisors who use a scientific risk assessment tool have two advantages:

• Marketing appeal, as they are taking time to assess the client's psychological well-being.
• Compliance appeal, as they have scientifically assessed the client's ability to handle risk.

All fields of human endeavour use measurement in some form, and each field has its own set of measuring tools and techniques.

Measuring a psychological attribute such as risk tolerance involves particular challenges because, firstly, there is no physical manifestation of the attribute and, secondly, there is no natural unit of measurement.

Since the 1890s psychologists and statisticians have been researching methodologies and techniques for psychological testing. The discipline they developed is known as psychometrics. Psychometric standards can be applied to questionnaires ranging from opinion polls and market surveys, through to tests of IQ, personality, aptitude, ability and the like.

Psychometric standards provide benchmarks against which a risk tolerance questionnaire can be evaluated.

A robust questionnaire is, in psychometric terms, one that is valid and reliable, where,

In brief, to meet psychometric standards, risk tolerance testing questionnaires must go through a rigorous development process comprising Usability trials and Norming trials.

In Usability trials, a large pool of questions is tested, for understandability and answerability, on representative samples of the population for which the test is intended. This can involve researchers sitting with subjects who are encouraged to verbalise their thoughts as they examine the questions. Questions which seem straightforward are often revealed to have poor understandability and/or answerability.

In Norming trials, questionnaires comprising questions with high Usability are tested on further representative samples and the results analysed statistically to determine the statistical value of the questions and the scoring algorithm. Questions which appear insightful are often revealed to have little or no statistical value in differentiating one respondent from another.

Typically, development requires multiple loops through both trial processes.

FinaMetrica was developed and tested in Australia over 4 years with the assistance of the University of New South Wales' Applied Psychology Unit.