The smaller of tolerance and capacity should constrain the strategy.
| Concept | Explanation | |---|---| | Objective | What the capital is intended to achieve. | | Time horizon | When the money may be needed. | | Risk tolerance | Willingness to experience uncertainty and loss. | | Risk capacity | Financial ability to absorb loss without impairing essential goals. | | Liquidity need | Amount and timing of cash that may be required. | | Legal, tax, or mandate constraint | Rules limiting eligible investments or activity. |
Key idea: Risk tolerance describes willingness; risk capacity describes ability. The smaller of the two should constrain the strategy.