In investing, risk tolerance is the willingness of an investor to tolerate risk in making investments. A high risk tolerance indicates a willingness to invest in more risky investments, and vice versa. In modern portfolio theory, higher returns are assumed to be rewarded by higher potential returns, so individual risk tolerance may limit the kind of return an investor can reasonably expect. Individual risk tolerance is based on psychological factors, such as comfort level, and other personal circumstances, such as years left until retirement (if any) and level of financial security. Financial advisors typically try to estimate their client’s risk tolerance before making an asset allocation strategy. The traditional approach is to increase the allocation to stocks as risk tolerance diminishes. In practice, risk tolerance is very difficult to quantify. |
