Difference between Risk Appetite, Risk Capacity and Risk Tolerance

The investment choices that an individual makes should be aligned to their financial risk profiles. The risk profile defines how much risk that particular investor is willing and able to take. This will determine his asset allocation strategy.

Financial Risk Appetite is the willingness of an investor to take risk. The asset class and investment options selected should reflect Risk Appetite.

However, Financial Risk Capacity is ability to take risk. Risk capacity will depend on personal factors like age, income levels, stability in job, investment horizon, net worth, etc.

While, Risk Tolerance of an investor defines the limits or boundaries of the risk that an investor is willing to take. e.g an investor will have a downside risk tolerance of 15% in the principal value invested.

Therefore, all these three Risk Parameters are very important in designing Investment Portfolio.