Matching Risk Capacity with Risk Exposure

Stock market returns are compensation for bearing risk. Higher expected returns require higher risk. Therefore, investors should take on as much risk as they have the capacity to hold — their risk capacity. One of the most effective ways to determine risk capacity is to examine five distinct dimensions: an investor's time horizon and liquidity needs, investment knowledge, attitude toward risk, net income, and net worth. This is explained more fully in Steps 10 and 11.

Step 1Risk ExposureRisk Capacity