What is risk tolerance?

Risk tolerance refers to an investor's capacity to withstand fluctuations in the value of their investments, which encompasses both the psychological and financial aspects of handling market volatility. This concept is crucial for establishing an investment strategy that aligns with an individual’s comfort level regarding potential losses and gains.

Understanding risk tolerance enables investors to make informed decisions that fit their financial goals and personal circumstances. For instance, someone with a high risk tolerance may choose to invest in more volatile assets with the potential for higher returns, while a person with low risk tolerance might prefer stable, lower-risk investments to avoid the stress of market swings.

Options that suggest different interpretations—such as an investor’s ability to earn high returns or a measure of risk in financial instruments—address aspects of investing but do not capture the core meaning of risk tolerance. Similarly, assigning a score to assess investment strategies does not directly relate to an individual’s personal ability to cope with investment fluctuations. Understanding risk tolerance is essential for effective portfolio management and aligning investment choices with a person's overall financial situation and goals.