Risk Tolerance vs. Risk Capacity
Willingness to bear loss versus financial ability to absorb it.
What is Risk Tolerance vs. Risk Capacity?
Tolerance is psychological - what a client can stomach without abandoning the plan. Capacity is arithmetic - what the balance sheet and time horizon can survive. The two frequently conflict, and good advice reconciles them explicitly.
Risk Tolerance vs. Risk Capacity: a worked example
A 30-year-old with high capacity but low tolerance may need a more conservative allocation than the math alone suggests, to keep them invested at all.
More terms in Risk & Return
Systematic Risk (Market Risk)
Risk affecting the whole market that diversification cannot remove.
Unsystematic Risk (Specific Risk)
Company- or industry-specific risk that diversification can eliminate.
Beta
How much a security moves relative to the overall market.
Alpha
Return above what the portfolio's risk exposure would predict.
Standard Deviation
How widely returns disperse around their average.
Sharpe Ratio
Excess return per unit of total volatility.
Correlation
How closely two assets move together, from -1 to +1.
Diversification
Spreading capital across assets so no single failure is fatal.