GLOSSARY TERM
Risk Capacity
Risk capacity means how much investment risk you can financially afford to take.
What does this mean in practice?
It is about your real-life situation, not just your feelings. Your risk capacity depends on things such as your income, savings, job security, debts, time horizon and how soon you may need the money. Someone with a stable income, a long time horizon and an emergency fund may have higher risk capacity than someone who may need the money soon. Younger investors often have higher risk capacity because they may have more time to recover from market declines, but this still depends on their overall financial situation. Risk capacity is different from risk tolerance, which is about how much risk you feel comfortable with emotionally.
Example
A person investing for retirement in 25 years may have higher risk capacity than someone who needs the money for a home purchase in 2 years, even if both feel equally comfortable with risk.
Why it matters
Risk capacity helps you choose a portfolio that fits your real financial situation. Taking more risk than you can afford can force you to sell at the wrong time.
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