Yesterday I mentioned that the seemingly monolithic idea of risk tolerance actually breaks down into between 3 and 5 components depending on how you look at it:* Risk tolerance* Risk capacity* Risk need* Risk perception* Risk composureLet’s briefly define each one.Risk ToleranceThis is a subjective measure of your willingness to take on risk.Risk CapacityThis is your ability to endure potential financial loss and still be able to achieve your goals. Mostly objective measure.Risk NeedHow much risk is required to reach a specific financial goal. Mostly objective measre.Risk PerceptionA person’s perception of the risk of a situation (vs. the actual risk). This is a subjective measure.Risk ComposureAbility to keep composure during circumstances where your perception of risk is changing rapidly. Also a subjective measure.Risk ProfileA combination of all of the above factors.I say the idea of risk tolerance actually breaks down into between 3 and 5 components because risk tolerance, risk perception, and risk composure are very closely related. If we think of them as facets of the same thing, then your risk profile can be seen as a combination of your risk tolerance/perception/composure, your risk need, and your risk capacity.-P
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