Risk Tolerance
How much scary stuff can you handle?
Category: Risk Management
Difficulty: Beginner
Definition
How much you can handle when your investments go down. Two questions: Can you afford it? Will it freak you out?
Two Parts to Risk Tolerance
Can You Afford to Lose Money?
Financial ability to handle losses - Steady job? - Emergency fund saved up? - When do you need this money? - Other savings or income?
Will You Freak Out?
Emotional ability to handle losses - Been through market crashes before? - Naturally calm or anxious person? - Can you watch your account go down 20%? - Do you panic and sell when markets drop?
Three Types of Investors
Scared (Low Risk)
“I can’t lose money”
This is you if: - Need money soon (less than 5 years) - Near retirement - Low income or few savings - Money stress keeps you awake
Your investments: - Mostly bonds and CDs - Maybe 20-30% stocks - Steady income over growth - Accept lower returns for safety
Balanced (Medium Risk)
“I want growth but not too much stress”
This is you if: - 10+ years until retirement - Steady job and emergency fund - Can handle some ups and downs - Want balance of growth and safety
Your investments: - Half stocks, half bonds (50-50 or 60-40) - Mix of different types - Some growth, some income - Rebalance once per year
Brave (High Risk)
“I want maximum growth and can handle wild swings”
This is you if: - Young with 20+ years to invest - Good income and strong finances - Comfortable with big swings up and down - Focused on building wealth long-term
Your investments: - Mostly stocks (70-100%) - Include small companies and growth stocks - Accept wild swings for higher returns - Don’t sell during market crashes
Common Mistakes
Thinking You’re Braver Than You Are
When markets are good, everyone feels brave - Never lived through a real crash - Only thinking about gains, not losses - Following friends with different money situations - Confusing gambling with investing
Being Too Scared
Playing it too safe has risks too - Safe investments might not beat inflation - Missing out on growth over time - Not saving enough for retirement
Saying One Thing, Doing Another
- Say you’re aggressive but buy only bonds
- Say you’re conservative but chase hot stocks
- Change your mind based on recent performance
Figure Out Your Risk Tolerance
Money Questions
- If I lost 20% of my investments, could I pay my bills?
- Do I have 6 months of expenses saved?
- When do I need this money?
- Do I have other income sources?
Emotion Questions
- How did I feel when COVID crashed markets in March 2020?
- Could I sleep if my account dropped $10,000 overnight?
- Would I panic and sell if markets crashed 30%?
- Do I check my accounts daily and stress about changes?
The Sleep Test
Most important question: “Can I sleep at night with this plan?”
If you’re losing sleep over your investments, you have too much risk.
Age Matters
Young (20s-30s)
- Time advantage: 30-40 years to recover
- Can be aggressive: Growth makes sense
- Should take risk: Unless it stresses you out
Middle Age (40s-50s)
- Balancing act: Growth vs. protection
- Life is expensive: Kids, mortgage, parents
- Be moderate: Mix growth and safety
Near Retirement (60s)
- Less time: Can’t recover from big losses
- Need income: Start thinking about income
- Get conservative: Move to safer stuff
Retired (70+)
- Protect what you have: Can’t afford losses
- Need income: Investments pay the bills
- Be very conservative: Safety over growth
Risk Tolerance Changes
What Changes Your Risk Tolerance
- Market crashes: Usually makes you more scared
- Life events: Marriage, kids, divorce, inheritance
- Job changes: New job, promotion, getting fired
- Health problems: Medical bills or disability
- Getting older: Usually become more conservative
When to Rethink It
- Every few years
- After big life changes
- After market crashes
- When your goals change
If You’re Not Sure
Start Careful
- Start conservative, add risk slowly
- Use target-date funds (auto-adjusts)
- Get professional help
- Practice with fake money first
Warning Signs You Have Too Much Risk
- Can’t explain your plan to someone else
- Check accounts daily and stress
- Make big changes based on recent news
- Follow hot tips instead of having a plan
The Bottom Line
Risk tolerance is personal. No right answer. Be honest about:
- What you can afford to lose
- What you can handle emotionally
- How much time you have
- What lets you sleep at night
Your plan should match your TRUE risk tolerance, not what you think it should be.
External Resources
- Assessment Tools: Risk Tolerance Questionnaire - Vanguard’s investor questionnaire
- Educational: Understanding Risk - SEC guide to investment risk