Net Worth and Risk Capital in Investing

Net worth measures the wealth of an entity, person, business, sector or country.

Your net worth is an indicator of your financial health. It’s the sum total of what you own minus what you owe. In financial terms, your net worth is the difference between your assets and your liabilities. Net worth relates to the maximum amount that you can invest.

Risk capital is the amount of funds that you expect to spend on the opportunity to generate gains.

In other words, it’s the amount that you can afford to lose if the investment happens to go bad. That said, you should make sure your risk capital only constitutes a small portion of your entire portfolio and that you can offset potential loss with more stable diversified investments. Understanding net worth and risk capital can help you get a feel for whether you should be risk-averse or risk-tolerant.

Here’s how to use net worth and risk capital to determine your ability to tolerate risk:

• If your net worth and risk capital are low, then it would make more sense to be risk-averse. Risk-averse investors are conservative and invest in low-risk stocks.
• If your net worth and risk capital are high, you can be risk-tolerant and opt for high-risk stocks.