Risk Tolerance vs Risk Capacity
Two related but distinct concepts. Risk TOLERANCE is the emotional ability to stomach drawdowns -- what the client can endure psychologically without panic-selling. Risk CAPACITY is the financial ability to absorb losses without breaking the plan -- how much the client can afford to lose given their income, savings, time horizon, and required spending. The two often diverge: a 62-year-old who lived through 2008 without selling has high tolerance but low capacity (a 30% drawdown in year 1 of retirement forces selling at the bottom to fund spending); a 30-year-old in their first market may have low tolerance but high capacity. The disciplined portfolio is sized to the LOWER of the two; documenting the divergence in the IPS is the practitioner-standard discipline.
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Related terms
Anti-Money-Laundering (AML) · Currency Transaction Report (CTR) · Investment Policy Statement (IPS) · Know Your Client (KYC) · Onboarding Workflow · Politically Exposed Person (PEP)
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