Risk tolerance
How much decline in investment value a person is willing and able to withstand in pursuit of potentially higher returns.
What it means
Risk tolerance has two sides. Willingness is emotional: how a person feels and acts when their investments drop. Ability, sometimes called risk capacity, is financial: how much loss they could absorb without derailing goals, based on time horizon, income stability, emergency savings and other assets.
Questionnaires from brokers and advisors try to measure it, but people often discover their true tolerance only during a real downturn. Matching a portfolio to risk tolerance matters because selling in a panic after a big drop can lock in losses. Risk tolerance usually changes with age, wealth and circumstances, so it is worth revisiting.
Example
Suppose someone holds a $100,000 portfolio that falls 30% in a bear market, to $70,000. If seeing that $30,000 drop would lead them to sell everything, a less stock-heavy allocation may better fit their tolerance.
How it’s used
- Choosing an asset allocation or target-date fund
- Completing an account-opening questionnaire at a brokerage or robo-advisor
- Reviewing a plan after a major life change
Related terms
Educational information only, not financial, tax or legal advice. Rules, limits and rates change; check the IRS, your lender or plan, or a qualified professional before acting.