Risk capital is your home-run money. It refers to funds that are invested in high-risk, high-reward investments. That can mean alternative investments such as venture capital, hedge funds, or private equity; or it could be funds used to start your own small business. It can also just be a subset of your portfolio set aside simply for taking on extra risk.
Generally speaking, risk capital is money that, if lost completely, would not have an overly harmful impact on you financially. It's money you can afford to lose.
The amount of risk capital at your disposal will change with time. When you're young, you may not mind taking a few swings for the fences. If one works out, great. If it flops, you still have 20 or 30 years to earn and save.
When you're older, you may not want to put as high of a percentage of your hard-earned savings at risk. However, because your nest egg has probably grown larger in dollar terms, a smaller percentage could nevertheless work out to a larger dollar amount. If that's the case, you could take more home-run swings without putting your financial future in jeopardy.
No matter how old or young, rich or poor, all investors have some percentage of their portfolio that could be considered risk capital. We work hard to diversify our investments across industries, asset classes, and so on. Many of us fail to consider risk as a factor that should be diversified as well.
Investing, at its core, is about accepting a certain amount of risk to achieve a reward. Risk is part of the game. Remain cognizant of that point, and don't be afraid to take a few calculated home-run swings when the opportunity presents itself.
At the end of the day, understanding your risk tolerance is critical to designing a long-term stock portfolio. Some investors can handle lots of risk -- market swings don't cause them to break a sweat. Others can't handle much risk at all and prefer to keep their savings in low-risk, low-volatility investments such as bonds or certificates of deposit.
There is no right or wrong answer -- to each his own. However, all investors should take the time to find out what is the right level of risk for them individually. To do that, one must consider one's own risk capital.
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