Risk Tolerance vs Risk Capacity
Risk tolerance is psychological — how much volatility you can stomach emotionally. Risk capacity is mathematical — how much loss your financial situation can absorb without derailing goals. Both matter, but capacity sets the ceiling.
The most common mistake: overestimating tolerance during bull markets, then panic-selling during crashes. A 30% portfolio drop on $500,000 is $150,000 gone on paper — experiencing that loss viscerally is different from knowing it intellectually.
Your true risk tolerance is revealed not by questionnaire but by your reaction to a real 20–30% drawdown. If you cannot sleep, your allocation is too aggressive — regardless of what your target date fund recommends.
- → Aggressive: 80–100% equity, tolerates 30–50% drawdowns
- → Moderate: 60/40 stocks-bonds, tolerates 20–30% drawdowns
- → Conservative: 40/60 or less equity, prioritises capital preservation
- → Match allocation to the profile that lets you sleep during crashes
- → Never override your true tolerance — the cost of panic-selling is permanent
