Risk Tolerance
Risk tolerance is the amount of risk that an inves-
tor is comfortable taking, or the degree of uncer-
tainty that an investor is able to handle. Risk tol-
erance often varies with age, income and finan-
cial goals. It can be determined by many meth-
ods, including questionnaires designed to reveal
the level at which an investor can invest, but still
be able to sleep at night.
Risk Capacity
Risk capacity, unlike tolerance, is the amount of
risk that the investor “must” take in order to
reach financial goals. The rate of return necessary
to reach these goals can be estimated by examin-
ing time frames and income requirements. Then,
rate of return information can be used to help
the investor decide upon the types of invest-
ments to engage in and, the level of risk to take
on. Income targets must first be calculated in order
to decide the amount of risk that may be required.
Balance of Risk
The problem many investors face is that their risk
tolerance and risk capacity are not the same.
When the amount of necessary risk exceeds the
level the investor is comfortable taking, a short-
fall most often will occur when it comes to reach-
ing future goals. On the other hand, when risk
tolerance is higher than necessary, undue risk
may be taken by the individual. Such investors
sometimes are sometimes referred to as risk
lovers.
Taking the time to understand your personal risk
situation may require self-discovery on your part,
along with some financial planning. While attain-
ing your financial goals is possible, reason and
judgment can be clouded when personal feelings
are left unchecked. Therefore, working with a
professional is helpful, if not critical.