Risk Tolerance
Definition
The degree of financial uncertainty and potential loss you're willing to accept in your investments, determined by your financial situation, time horizon, and emotional comfort with volatility.
Risk tolerance is the intersection of your financial ability to take risk and your psychological willingness to accept it. These don't always align — someone with a 30-year time horizon (high risk capacity) might still panic-sell during a 20% drawdown (low risk willingness).
Financial risk capacity is relatively objective: longer time horizons, stable income, adequate emergency funds, and fewer dependents all increase your ability to absorb investment losses. Someone with 30 years until retirement can weather multiple market cycles; someone retiring next year cannot.
Psychological risk tolerance is subjective and harder to assess. Many investors overestimate their tolerance in bull markets and discover their true tolerance during bear markets — when it's too late. The question isn't "can I handle volatility in theory?" but "will I sell in a panic when my portfolio drops 30%?"
Risk tolerance directly determines your ideal asset allocation. Aggressive investors (high tolerance) might hold 90%+ stocks. Conservative investors might hold 50% bonds. Moderate investors fall in between. The right allocation is one that lets you stay invested through downturns without making emotionally driven decisions.
Questionnaires and surveys attempt to measure risk tolerance, but they're imperfect. The best test is your actual behavior during market stress. If you checked your portfolio anxiously during the 2020 COVID crash, your real risk tolerance may be lower than you think, regardless of what a survey says.
Where this appears in Clarity
Clarity automatically tracks and calculates these concepts across your connected accounts.
Related Terms
Frequently Asked Questions
How do I determine my risk tolerance?
Consider your time horizon (longer = more tolerance), financial stability (emergency fund, stable income), investment goals, and honestly assess your emotional response to market drops. If a 30% portfolio decline would cause you to sell, your allocation should be more conservative regardless of your age.
Does risk tolerance change over time?
Yes. Risk tolerance typically decreases as you approach retirement (shorter time horizon, greater need for stability). Major life events (marriage, children, inheritance) also shift tolerance. Review your allocation annually or after significant life changes.