What does risk tolerance refer to?

Risk tolerance refers to an investor's capacity and readiness to accept the possibility of losing some or all of their original investment. This concept encompasses both the emotional and financial aspects of investing; it reflects how much volatility an investor can handle in their portfolio without making rash decisions.

Understanding risk tolerance is crucial because it helps inform investment choices that align with an individual's comfort level and financial situation. For example, an investor with a high risk tolerance might opt for more aggressive investments that have the potential for higher returns but also come with a greater chance of loss. Conversely, someone with a low risk tolerance may prefer stable, less volatile investments that offer more security but potentially lower returns.

This understanding is foundational in portfolio management, as it guides investors in building a strategy that aligns with their personal circumstances and goals, ensuring they remain steady through market fluctuations.