What Is Risk Tolerance?
Risk tolerance is how much ups and downs in your investments you can handle, both with your money and with your nerves.
Two sides of risk tolerance
- Ability: can you afford a big drop? Someone with a steady job and decades until retirement can.
- Willingness: can you sleep at night when your portfolio is down 30%? Some people panic and sell.
A simple test
Imagine you invested $10,000 and a year later it is worth $7,000. Would you sell, wait, or buy more? Your honest answer says a lot. People often overestimate their tolerance until a real bear market arrives.
Why it matters
Your risk tolerance should guide your asset allocation. A mix that is too risky for you is likely to be sold at the worst time. A slightly more careful mix that you stick with often does better.
Related terms
Asset allocationHow you split money between stocks, bonds and cash.
VolatilityHow much and how fast a price moves.
DiversificationNot putting all your money in one place.
PortfolioEverything you have invested, together.
Bear marketA drop of 20% or more from the top.
BetaHow much a stock moves compared with the market.