Risk: Tolerance vs. Capacity
These two concepts are related but different.
What do you think of when you hear the word “risk”? Skydiving? Starting a business? Seems like we’ve all been weighing risks in one way or another over the past year, but the concept of risk is one we talk about often in the world of financial planning.
In my job, risk tolerance refers to the amount of risk or the degree of uncertainty that a client is willing to accept within their investment portfolio. I like to visualize this as a roller coaster. High-risk folks are comfortable with steep climbs as well as the big drop on the other side. Those who are more risk-averse prefers a smoother, flatter ride.
Risk capacity is a related but different concept. Your risk tolerance refers to your acceptance of different results, whereas your risk capacity refers to the amount of risk your financial plan could or must take. Tolerance refers to your comfort level. Capacity refers to how much room there is for risk in your financial plan.
When talking with my client families, I always strive to gauge both their risk tolerance and their capacity, as they are both important when building a customized financial plan and investment strategy.
If you have questions about how much risk you’re currently taking or what your risk capacity is, our team is always here to help. Need a review of your current financial plan? Initial meetings are always complimentary. Just give us a call.