Now Is A Great Time To Revisit Your Risk Tolerance

Despite all the mayhem in the world today, the market has remained pretty resilient, hasn’t it? But even as summer is coming to a close and kids are going back to school, we’re only one short season removed from a market whipsaw of historic proportions.

It was just in April (of this year) that the market suffered double-digit losses in only days—then recouped most of those losses in a single day, before ultimately ascending to new highs. So, while the sting of those sharp losses may have been dulled by the rebound, my inclination is to remind you of the losses and invite you to revisit your risk tolerance and the degree to which your portfolio accurately reflects it.

Why Reconsider My Risk Tolerance Regularly?

Why is that important? Because risk tolerance is not a set-it-and-forget-it, one-time decision; it’s a living, breathing reflection of your personal posture to the (investing) world around us.

This is important in part because the markets are always moving, but even more so because we are always changing. Life isn’t linear, and neither is our risk tolerance. And it’s not just because your understanding of and posture toward investments specifically shifts, though it does; it’s also because changes in our life and work will impact our tolerance for market risk.

What Does Risk Tolerance Really Mean?

We’ve historically tended to look at risk tolerance through too small of a lens, only considering one or two variables, when I believe we should really be considering at least three:

• Your ability to assume risk is related to your time horizon.
• Your willingness to assume risk is related to your emotional response to volatility.
• Your need to assume risk is related to the amount of risk you need to take in order to meet your goals.

Your time horizon, or ability to assume risk, is often used as a single guiding factor (especially in target-date funds) for risk tolerance. It simply assumes, from a statistical perspective, that the farther away the date is when you may need to utilize the money you’re investing, the greater your ability to assume risk.

One of the oldest risk tolerance equations was to subtract your age from 100 and use the corresponding answer as the percentage of your portfolio that should be invested in stocks, or more growth-oriented investments.

Your need to take risk is also something that can be calculated numerically, estimating the rate of return required to meet your goals in the future. For example, if your goals are more aggressive, requiring a higher average rate of return, the presumption is that you need to take more risk in order to meet your goals. Whereas, if you only needed, say, 5% average annual return to meet your future goals, you could presumably take more risk.

The challenge with both of these factors—the two most common in oversimplified risk tolerance short cuts—is that they are regularly ignored by the third and often most powerful (albeit least calculable) factor that gauges your gut.

Our willingness to assume risk is the gut factor. It’s the answer to the question, “So just how much market volatility can you handle before you give up?” And despite the financial industry’s attempts to make tangible this inherently intangible factor (often through questionnaires that foist a host of hypothetical scenarios onto an investor), I’ve found the best way to determine your willingness is to live through market volatility and calibrate as you go.

The especially tricky part is that our willingness to assume risk is not only changed because of our direct reactions to the market itself, but it can (and often should) change due to factors well outside of our finance textbooks. Indeed, your tolerance of market risk could change over time, or even overnight, due to the birth of a child, the death of a parent, a job change, a move, a marriage, a divorce, or any other number of factors.

How Can We Better Gauge Our Tolerance And Change Our Portfolios?

Let’s start with a different tactic that utilizes a four-bucket approach to risk and portfolio management. Because I believe risk isn’t just about volatility or investment returns, I encourage clients to frame their financial lives through four interrelated lenses: Grow, Protect, Give, and Live.

Each of these can influence how we think about risk and how we build portfolios that are better aligned with our lives—not just our timelines or tolerance scores. And while the precise order that we address them could be different for every client, I’m going to start by filling the two buckets that also tend to be the receptacles for some of our greatest fears in financial planning.

Protect: How much money do you need to keep “in the bank” to sleep well at night?

As financial advisors, we’ve attempted to use various calculations to recommend amounts for someone to keep in their emergency reserves—think three-to-six-to-twelve months of living expenses—a professional lifetime of working with clients suggests that this number is almost an entirely emotional equation. That’s one of the reasons that it is often such a round number: $10,000, $50,000, $100,000, even $1 million.

And I’m simply not inclined to argue with your gut, so unless I think you’re warehousing so much in cash that it’s likely to hurt you in the future, I’m not sure we need to get any more scientific in filling the Protect bucket than by asking, “So, how much money in the bank helps you sleep at night?”

And by the way, I put “in the bank” in quotes because there are other ways to ensure that your money is as secure as possible, but FDIC-insured savings or CDs are likely the gold standard. But please take note, because if you are investing significant amounts of cash, there are limits on how much of your savings is actually secured by the FDIC, regularly requiring us to look to other cash management tools to ensure that your emergency savings is as secure as possible.

Live: How many years of income would you like to have in stabler investments?

The idea here is that if you’re able to fill your Live bucket with enough money for the mid-term, you’re free to worry less about the market’s machinations in the short term. And while this, too, is largely an emotional decision, we may be able to better inform your gut.

For example, depending on the analysis and how you define “the market,” you’ll likely find that the market has a positive rate of return in about 87% of the five-year rolling periods, 94% of the rolling 10-year periods, and 100% of the 20-year periods. And while I’d never want to suggest that you build your portfolio solely based on historical figures that may not replicate themselves in the future, I do believe this is a reasonable guide for determining how much we need in the Live bucket.

If you’re a more conservative investor, you might opt for 10, 15, or even 20 years’ worth of income in your Live bucket—and if you’re more aggressive, you might opt for five or seven.

And what if you’re still working? Do you need to populate your Live bucket at all while you’re still receiving a paycheck? This may depend on your labor capital risk—basically how volatile and secure is your household income? For example, a tenured professor has a low labor capital risk, while a mortgage broker who lives off of commission sales may have a higher labor capital risk. The higher the risk, the more you might consider putting in your Live bucket, even while you’re still working.

What types of investments might live in your Live bucket? While this particular post is more about strategic positioning than tactical details, it’s reasonable to assume that the assets found in the Live bucket may take on slightly more risk than the Protect bucket, but definitely less than the Grow bucket. So think about more conservative fixed-income vehicles, pension, and annuity income here.

Then, once the Protect and Live buckets are filled, I believe it frees investors to be even better growth investors.

Grow: Are you still positioned to grow in line with your goals?

The market has a tendency to reward long-term investors while often confounding, or even punishing, short-term investors. But once you’re freed from the worry of short- and mid-term volatility (a la the Protect and Live buckets), you may feel a sense of release to position your Grow bucket in a way that is designed to maximize your potential reward by taking more risk.

This bucket is where your stocks, equity based mutual funds and ETFs, private equity, venture capital, and hedge funds would reside.

Give: How are you invested for anyone other than you?

I’ve met very few people who were inclined to label themselves as philanthropic, or even charitable. However, I know many people who are extremely generous, both to those they love and the causes that are most important to them. The Give bucket, therefore, is the receptacle (and potentially receptacles) that are the holding place for these investments.

These could be 529 education savings plans or custodial accounts for your children, trusts that are outlined in your estate planning documents, donor advised funds (DAFs), or even foundations and family offices for those of more significant means.

The fascinating part about how these assets are invested is that it’s no longer about you and your risk tolerance—it’s about the ability, willingness, and need to take risk of those for whom the assets are designated. Therefore, it may even become a collaboration to determine how best to invest your Give bucket.

Conclusion

So yes, the market rebounded. And yes, your portfolio may have “recovered.” But resilience in numbers isn’t the same as resilience in you. Therefore, if the last market swing made you uneasy—even briefly—it’s worth examining whether your portfolio still reflects your reality. Because I believe risk tolerance isn’t just a personality trait or a math problem. It’s a living profile of your financial life, shaped by your goals, values, and experiences, as well as your ability, willingness, and need to assume risk. And when you construct your portfolio through the Grow, Protect, Give, Live (GPGL) model, you’re not just managing investments—you’re designing a life that’s more intentional and aligned with what’s most important to you.