Risk capacity

How much loss your circumstances could actually absorb without damaging your plans - a financial fact, separate from how a loss would make you feel.

Example

Someone needing a deposit in two years has very little capacity for a large decline, regardless of how calmly they would watch one happen.

Important

Capacity and tolerance move independently, and an allocation must respect whichever is smaller. A high tolerance cannot pay for a shortfall.

Related terms

• Risk tolerance — How much decline in the value of your investments you can withstand financially and emotionally without abandoning your plan.
• Asset allocation — The split of capital across broad asset types - equities, bonds, property, cash - expressed as target percentages. The decision that sits above choosing individual holdings.
• Time horizon — How long before you plan to spend the money you are investing.

Lessons that explain it

• For most readers, nowhere - and the exceptions are narrow — Derivatives can hedge specific risks or adjust a portfolio at a known cost, but they are not needed to invest well, and for most people the right allocation is zero. (8 min)
• Asset allocation: the decision above the holdings — How much you hold in each broad type of asset shapes your experience far more than which particular items you choose inside them - and it is the decision most people spend the least time on. (14 min)
• Size each investment for the likely loss, not the hoped-for win — Once an investment is attractive, the remaining decision is how much. Position size should reflect the probability of losing everything, the portfolio you plan to build and what you can afford to lose. (10 min)
• What a portfolio is actually for — A portfolio is not a collection of good ideas. It is an instrument built to deliver specific amounts of money at specific times, and almost every construction question becomes answerable once that is written down. (10 min)
• Cash is a decision, not the absence of one — Holding cash has a cost measured against what else the money could earn, and a value in optionality and sleep. Sizing it deliberately is part of portfolio construction rather than what is left over. (10 min)
• A leveraged cousin of your stock portfolio, not a separate world — Buyout exposure behaves more like leveraged small and mid-sized company equity than its smooth reports suggest, so it belongs in the equity bucket and only in modest size. (8 min)

All 578 terms in the Investing glossary