It’s a common question—but the answer is more nuanced than it may seem at first glance. According to the CFA Institute, risk tolerance can be divided into two key components: your ability to take risk and your willingness to take risk. Let’s break down the difference.
Ability to Take Risk
Your ability to take risk depends on a variety of factors, including your financial goals, time horizon, and liquidity needs. For example, if you have a long investment time horizon, you likely have a higher ability to take risk. That’s because, even if the market experiences a significant drawdown, you have time to recover.
On the other hand, if you’ll need a large lump sum or income from your investments within the next one to three years, your ability to take risk is limited. In that case, preserving capital may take priority over seeking growth.
This is one reason why individuals with significant wealth can often afford to take more risk—they typically have longer horizons and fewer near-term financial constraints. But just because someone can take more risk doesn’t mean they will.
Willingness to Take Risk
Willingness to take risk is more emotional and subjective. We frequently meet with clients who, based on their financial situation and minimal liquidity needs, could comfortably handle more risk in their portfolio. Yet, they choose not to. Why? Because volatility can be unsettling.
Some investors simply don't want to see their account balances drop—even temporarily. And that's perfectly fine. If their current allocation still allows them to meet their long-term financial goals, there's no issue with a more conservative approach.
However, if a client can’t afford to be overly conservative and still reach their goals, we see it as our role to educate them. We aim to provide reassurance through market cycles and adjust their portfolio as needed. Ultimately, our goal is to balance comfort with progress.
If you’re unsure how much risk is appropriate for your portfolio, our advisors are here to help. Let’s build a financial plan that aligns with both your goals and comfort level.
Have thoughts on this topic? Drop a comment or share this post with someone following the markets closely.
If you found this helpful, consider following for weekly insights on markets, macro trends, and smart investing.
— HPK Provident Advisors
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. Economic forecasts set forth may not develop as predicted