What is the difference between risk tolerance and risk capacity?

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If you’re interested in making investments, two terms you’ll likely come across are risk tolerance and risk capacity.

While similar in name, an investor’s risk capacity and their risk tolerance are usually independent of one another. Below, we’ll cover both areas in more depth.

What is risk tolerance?

In simple terms, risk tolerance refers to the level of risk that an individual is willing to take on.

As a result, it is sometimes described as “attitude to risk”. It’s worth noting that being able to measure your attitude for risk accurately isn’t always easy. Risk might involve the excitement at the chance to make gains, but also includes tolerating the potential that losses can occur. It also requires the ability to withstand fluctuations in the market, and an understanding of the inability to predict the future with absolute certainty.

What is risk capacity?

How much risk that an individual can take on is referred to as risk capacity, and is determined by an investor’s personal financial situation.

A person’s risk tolerance might never change during their life. However, risk capacity is a far more flexible variable, and can change according to specific financial and personal goals, and the timeline to achieve them in.

For instance, if an investor must manage their mortgage, a business, children approaching further education age, or elderly parents who are dependent on them financially, they may have less capacity for risk than an investor who is single and financially solvent.

For a full assessment of your risk tolerance, risk capacity and independent financial advice in Chester, touch base with our team at Hartey Wealth Management today.

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