What Is Risk Tolerance?
Your ability — financially and emotionally — to handle investment losses.
The Full Definition
Risk tolerance is your capacity to endure investment losses without making panic decisions. It has two components: financial (can your situation survive a 30% drop without forcing you to sell?) and emotional (can you sleep at night through a market crash without selling?). Many investors overestimate their risk tolerance during bull markets and discover their true tolerance during the first significant correction. Building a portfolio aligned with your real risk tolerance is one of the most important decisions you'll make as an investor.
Real-World Example
Someone who needs their investment money within 3 years has low financial risk tolerance regardless of their emotions — they simply can't afford to wait for a market recovery. Someone who panics and sells during every 10% dip has low emotional risk tolerance even if they can afford to hold.