What is risk tolerance?

Risk tolerance refers to an investor's ability and willingness to endure fluctuations in investment value. This concept is crucial in financial planning and investment management, as it determines how much volatility an investor can withstand in their portfolio without making impulsive decisions or abandoning their investment strategy. Understanding risk tolerance helps investors to align their investment choices with their financial goals, ensuring they are comfortable with the level of risk associated with their investments.

While emotional resilience can play a role in how individuals react to market fluctuations, it does not encompass the full definition of risk tolerance. Similarly, while being aware of the maximum loss an investor can accept is important, it is a narrower aspect of risk tolerance, which looks more broadly at the overall capacity and willingness to face fluctuations in value over time. The total investment amount is unrelated to risk tolerance, as this measure does not indicate how much risk an investor is comfortable assuming relative to the potential gains or losses.