Building a portfolio
Risk tolerance
How much decline you can live through without changing your plan.
How it works
Tolerance has two halves that get confused: capacity, which is financial and objective, and willingness, which is emotional. Someone with thirty years to retirement has high capacity and may still have low willingness.
The binding constraint is whichever is lower. A portfolio built for your capacity that exceeds your willingness gets abandoned in the first bad year, which is worse than never having held it.
Where it misleads people
Risk questionnaires measure willingness during calm markets, and willingness measured in calm markets is systematically overstated. The honest test is what you did in the last real decline.
Related terms
- Asset allocationHow you divide money between asset classes — the decision that drives most of your long-run experience.
- DrawdownThe fall from a portfolio’s previous peak to its lowest point before it recovers.
- Time horizonHow long until you need the money — the single fact that should shape most of your other decisions.
- Loss aversionThe tendency to feel a loss roughly twice as intensely as an equivalent gain.
Mentioned in
More in Building a portfolio
- Safe withdrawal rate
- Rebalancing band
- Sequence-of-returns risk
- Rebalancing
- Strategic asset allocation
- Modern portfolio theory
- Tactical asset allocation
- Home bias
All 20 Building a portfolio terms · The full glossary, 433 terms
Educational reference only. Nothing here is investment advice or a recommendation to buy or sell anything, and tax treatment depends on your own circumstances and the country you are in.