Risk Tolerance
Explanation: Risk tolerance is the degree of variability in investment returns that an investor is willing to withstand. It reflects an individual’s capacity and willingness to lose some or all of an investment in exchange for potential greater returns. Factors influencing risk tolerance include financial goals, investment horizon, income, and comfort with uncertainty and market fluctuations.
Example: A young investor with a stable job and no immediate financial obligations might have a high risk tolerance, opting for a portfolio with a higher percentage of stocks. Conversely, a retiree relying on investment income might have a lower risk tolerance, preferring bonds and other stable, income-generating investments.
Reference Link: For more information on risk tolerance, visit Investopedia’s Risk Tolerance.
FAQs:
- How is risk tolerance assessed?
- Through questionnaires, financial planning discussions, and evaluating personal comfort with market volatility and potential losses.
- Why is understanding risk tolerance important?
- It helps tailor investment strategies to match an investor’s comfort level, minimizing the risk of panic selling during market downturns.
- Can risk tolerance change over time?
- Yes, it can change with life events, financial goals, age, and changes in income or financial stability.
- What is the difference between risk tolerance and risk capacity?
- Risk tolerance is about willingness to take risks, while risk capacity is about the ability to absorb potential losses without affecting financial stability.
- How can investors manage risk?
- By diversifying investments, setting realistic financial goals, and regularly reviewing and adjusting their portfolios.