What does risk tolerance refer to?

Risk tolerance refers to an individual's capacity to endure investment losses, which is crucial when making investment decisions. It encompasses both the psychological comfort level with uncertainty and the financial ability to withstand losses without a significant detriment to one’s overall financial situation. Understanding risk tolerance is essential for building a suitable investment portfolio that aligns with one's goals and financial circumstances.

Individuals with a high risk tolerance may be more willing to invest in volatile assets, such as stocks, which have the potential for greater returns but also come with significant short-term fluctuations. Conversely, those with a low risk tolerance might prefer safer investments like bonds or savings accounts, which offer more stability but typically provide lower returns. This evaluation of risk tolerance helps guide investors toward appropriate strategies that can help them achieve financial security while aligning with their comfort levels regarding risk.