The Risk-Right Portfolio: Where Confidence Meets Strategy

When we think about investing, risk is often the first word that comes to mind, and usually not in a good way. Risk is not something to fear, however.  It is something to respect, acknowledge that it exists, and understand how we work with it. Just like you wouldn’t go into a mission without assessing the terrain or the opponent, you shouldn’t invest without first assessing how much risk you can take, how much you’re comfortable with, and how much risk you actually need.

Let’s break that down.

Risk Capacity: What You Can Financially Handle

Risk capacity is your financial ability to take on risk. It’s objective. It has nothing to do with whether the headlines are making you nervous or how you feel about a market drop. Instead, it’s about your timeline, your income, and your resources.

• Have a long time before retirement? This usually results in the capacity to take on more risk as your investment would have time to recover from any short-term declines in the market.

• Have reliable retirement income sources like military retirement, disability payments, or social security? This could afford you more risk capacity depending on the gap, if any exists, between your guaranteed retirement income and your retirement expenses.

• Need that money in 2–3 years for a house down payment? Your capacity to absorb market losses is now reduced as your investments likely do not have time to recover from sudden market declines.   

Your Risk Capacity defines what kind of losses you can afford to recover from, and how much volatility your plan can withstand.

Risk Tolerance: How Comfortable You Are with Market Volatility

This one’s more personal. Risk tolerance is your emotional and psychological response to market swings. Can you stomach a 20% drop without panicking? Or do you lose sleep at the idea of losing any money at all?

We can measure this through questionnaires or simulations, but often, past behavior tells the real story. If you bailed out in 2000, 2008, or 2020 and moved to cash, your tolerance might be lower than you think.

This isn’t about judging your comfort level; it’s about respecting it. A plan that keeps you up at night isn’t a plan that will last.

Risk Need: How Much Risk Do You Actually Require

Here’s where planning comes in. Risk need is how much risk you need to take to meet your goals. That might sound backward; why would you need risk? But the truth is, without some level of growth, most long-term goals (like retirement or college funding) are hard to reach.

Sometimes we overestimate this need and take on more risk than necessary. Other times, we realize we’ve been too conservative and need to make some adjustments, whether that’s investing more, saving more, or pushing back a goal by a few years.

The Real Work: Balancing All Three

Ideally, your risk capacity, tolerance, and need all line up. But often, they don’t. Maybe you have the capacity to take risk, but not the tolerance. Maybe you don’t need to take much risk, but you’re chasing returns anyway. Or maybe your capacity is low, your tolerance is high, and your goals require more growth than either can support.

That’s where thoughtful planning matters most.

Application: Your Risk Allocation

Historically, equities, whether individual holdings or a well-diversified Exchange Traded Fund (ETF), provides the potential for high returns, but also larger losses.  In other words, when people generally think about large market swings, they are usually thinking about what is happening in the equities market.  Fixed income instruments such as bonds or treasuries, provide the investor more stability, but a lower overall return.  Fixed income instruments are often seen as “the boring” investments, but for a good reason.

A risk allocation is the tactical application of the three risk categories of capacity, tolerance, and need, into an overall balance of equities and fixed income assets.  Ultimately, the percentage of equites to fixed income should be a reflection of your responses to these areas.  If you have a high risk allocation score, your allocation may be a 80/20 or even 90/10.  If you have a low score, you may have an allocation of 60/40 or 50/50.   

Ultimately, investment risk isn’t a single dial you turn up or down; it’s a system that needs to be aligned with your financial life and your personality. By considering what you can handle, what you’re comfortable with, and what you actually need, you give yourself the best chance to invest with confidence and to stick with your plan, no matter what the headlines say.

Disclaimer: This article is provided for educational, general information, and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation.  Read the full disclosure.