Risk Capacity

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Risk Capacity is the amount of risk an individual can afford to take. It is a financial construct.

A person's risk capacity is the maximum risk that person can afford to take without risking the derailment of their personal financial plans if a risked negative outcome actually happens.

It represents an absolute constraint on strategy selection. An individual should not embark on a course of action where the worst case scenario involves the possibility, no matter how remote, of a loss greater than his or her risk capacity.

An adviser would use financial planning software to determine a client's risk capacity through Monte Carlo modelling, stress testing or the like.

Other risk-related constructs include Risk Tolerance, Risk Required and Risk Perceived. See Balancing Risk about how to deal with all four risk constructs.

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