Risk Tolerance
How much volatility and loss an investor is emotionally willing to endure without abandoning their plan.
Formula
Test: the largest decline the investor would hold through without selling, judged by past behaviour rather than by stated intention
Unit
%
In depth
Risk tolerance is psychological and risk capacity is financial, and confusing them is the most consequential error in portfolio construction. Stated tolerance is systematically overstated in calm markets, because people answering a questionnaire are not experiencing a 40% decline. The only reliable evidence is behaviour in a previous fall — what the investor actually did, not what they now believe they would do. A portfolio built for a tolerance the investor does not have will be abandoned at the bottom, which converts a temporary decline into a permanent loss.
Worked example
An investor states they could hold through a 40% fall. In the previous decline they sold after 18%. The portfolio should be built for 18%, because that is the number supported by evidence.
Illustrative figures, chosen so the arithmetic is easy to follow. Not a live price and not a valuation of any company.
Educational reference only
This entry explains what “Risk Tolerance” means. It is not investment advice and not a recommendation to buy or sell any security. Any numbers above are illustrative, not live prices, and nothing here predicts price direction or rates a stock. Consider your own circumstances and consult a SEBI-registered investment adviser before acting.