Understanding your risk tolerance can help you become your best self as an investor and reach your financial goals. 

But what is risk tolerance, exactly? And how does it work?

We’ll cover what risk tolerance is, how it shapes your investing, and how to figure out your own risk tolerance — so you can use it to your advantage!

Step 1: What is risk tolerance?

Risk tolerance describes how much risk and potential loss you’re willing (and able) to handle as an investor. It’s determined by a wide range of factors, including your financial situation today, your goals for the future, your personality, and your personal history with money.

Here’s why it matters — there are a lot of different things you can invest in. Some of those things have been historically stable. Others have often changed in value — by a lot — so they’re seen as a lot more risky.

The stock market, for example, has offered plenty of opportunities to both make and lose money. Higher potential rewards, more potential risk.

Individual savings accounts, on the other hand, are insured by the FDIC up to a certain amount. They’re designed not to be very risky, but the interest rates they offer aren’t very high. Lower rewards, lower risk.

There’s a wide range of investments out there, with a wide historical range of risk and reward — mutual funds, ETFs, bonds, real estate … the list goes on. 

Understanding your risk tolerance helps you make the best choices for your situation. It takes into account the amount of risk you’re willing to take, the rewards you hope to reap, and the time you have to work with.

Step 2: Factors that impact your risk tolerance

As an investor, you may have specific goals — like having a certain amount of money saved up by the time your kids are old enough to go to college, or by the time you retire.

Maybe you have a lot of time left to do that, and maybe you don’t. But trying to make more money in less time generally means taking more risk in your investments — which means you could lose more too. 

Maybe that’s okay with you, and maybe it isn’t. 

To figure that out, here are some things you’ll want to think about:

  • Investment objectives. Your goals determine how much money you need — and how much risk you might have to navigate to get there. If your goal is to retire in Waikiki, you might choose to be more adventurous with your investments. If your goal is to buy a VW bus and tour the countryside, you should be able to invest more conservatively.
  • Age. Your age tends to be a factor in your risk tolerance because it affects your time horizon (more on this below). A 30-year-old parent and a 40-year-old parent, for example, may have the same amount of time left to save for their child’s college education, but one is (probably) closer to retirement than the other.
  • Time horizon. Your time horizon measures how long you have left to meet your goals. The longer you can stay invested, the more time your portfolio has to overcome any losses you might take. Shorter time horizons, on the other hand, may limit the level of risk you can afford to take.
  • Finances and lifestyle. If you have a large paycheck (or a large portfolio) and few expenses, you may be able to stomach more market losses. You wouldn’t like losing money, but you could survive it. With a smaller income or large debts, though, a similar loss could feel devastating. 
  • Life circumstances. Your risk tolerance will probably change throughout your life. Getting married, having children, buying a home, caring for aging parents, incurring sudden medical expenses, or even starting your own business can all change your risk tolerance.
  • Personality. Some people are inherently more comfortable with investment risk than others. Your personal history with money can also affect your risk tolerance. If your natural risk tolerance is low, start with a conservative investment strategy that fits your comfort zone.
  • Comfort with market volatility. Market fluctuations are an inherent part of investing. As you first start investing, you might hang on every short-term price change — minute by minute, hour by hour. Over time, you’ll probably check in less often — and worry less when you do. 
  • Experience. Learning how to invest is like learning anything else — as you try different things, you’re bound to make some mistakes. Respect your risk tolerance, and be patient. The more you know about investing, the more comfortable you may feel trading risk for gains. 

Step 3: What is your risk tolerance?

Remember, your risk tolerance isn’t static: it changes with your goals, your finances, and your life experience. You might not know how you’re going to react to massive volatility until it smacks you in the face for the first time. 

But that doesn’t mean you have to go in blind. The following questions can help you figure out where your comfort level is today — and how your risk tolerance might change over time.

  • Sudden, significant losses: If your portfolio dropped 30% overnight, would you sell in a panic? Or would you wait patiently for market conditions to recover — no matter how long it takes?
  • Preserving vs. growing: What are your investing goals? A long, quiet retirement? Building the home of your dreams? Your goals can help you decide whether you’re playing offense or defense — generating extra income to grow your wealth, or preserving what you have over the long haul.
  • Time horizon: What’s your timeline for each of your investing objectives? Do you need the money in less than 5 years, or in another 3 decades? 
  • Risk capacity: Do you have extra savings or income? How much money can you afford to tie up in investments for a while? And how much can you afford to lose? More specifically, what would happen to your goals and timeline if your portfolio took 2-3 years to recover?

Step 4: Building your risk tolerance into your investment strategy

Your risk tolerance should affect your investment strategy — your game plan for buying, holding, and selling assets. 

Investments that generate high returns tend to carry greater risk, while lower-risk assets tend to grow more slowly. Your risk tolerance helps you determine your best balance of investments at this particular time in your life.

For instance, a conservative investor with a low risk tolerance might focus on preserving capital and earning steady but moderate income. They might hold asset classes like:

  • Fixed-income bonds and Treasuries
  • Cash deposited in high-yield savings accounts or Certificates of deposit (CDs)  
  • Precious metals like gold and silver
  • Stocks from well-established brands that have paid historically reliable dividends (blue chip stocks)

By contrast, an aggressive investor with a high risk tolerance might invest more heavily in a wider range of assets, including:

  • Stocks that have been historically volatile
  • Real estate that ties up their capital
  • Private investments like private equity, venture capital, or private debt

Risk-loving investors might even dabble in more volatile alternative asset classes — subject to large price swings — like commodities or cryptocurrencies (crypto). 

Step 5: Levels of risk — which of these feels most like you?

Risk tolerance levels vary, but this basic framework can help you identify your unique risk profile and decide which best suits your investment goals. 

In general, investors are classified according to 3 risk tolerance levels: 

  1. High risk tolerance (aggressive investors)
  2. Moderate risk tolerance (moderate investors)
  3. Low risk tolerance (conservative investors)

High risk tolerance

Is your risk tolerance high?

Aggressive investors risk big losses to chase higher returns. Typically, these investors focus more on growth than producing steady income or preserving their initial investment. 

You might have a high risk tolerance if you’re:

  • Younger (20s to 30s) 
  • Very comfortable financially (easily able to absorb financial shocks)
  • Willing to take risks to earn rewards
  • Chasing growth over safety or income

High risk tolerance example

Investors with high risk tolerances typically focus on assets with substantial growth potential like stocks and real estate. Some might also dabble in notoriously risky “alternative assets” like commodities, foreign exchange (forex), or cryptocurrencies. 

Imagine Ariana A. She’s 25 years old and doesn’t plan to retire for another 40 years. Though she’s still new to her (future) high-earning career, she hopes to put a down payment on a house in the next decade.

As an investor with a high-risk profile, Ariana’s portfolio might look like this:

  • 80-90% stocks 
  • 5-10% bonds
  • 5-10% alternatives like real estate, commodities, private investments
  • 2-5% cash

Pros of a high-risk profile

  • Opportunities for longer-term growth
  • Wide variety of assets to choose from
  • Diversify into different risk-reward profiles across industries 

Cons of a high-risk profile

  • Higher chance of loss
  • Market swings may cause anxiety about portfolio performance
  • May not be suitable for older or less financially stable investors

Moderate risk tolerance

Is your risk tolerance moderate?

Moderate investors want to grow their money while taking precautions to safeguard their earnings. Generally, the goal is to balance risk and reward. 

You might have a moderate risk tolerance if you’re:

  • Middle-age (40s to early 50s) 
  • Comfortable financially (able to absorb some financial shocks)
  • Willing to take some risks, but prefer to preserve capital when possible
  • Opting for a balanced mix of safety, income, and growth

Moderate risk tolerance example

Investors with moderate risk tolerance focus on achieving the right balance of risky versus safe asset classes. They often include a high proportion of stocks and bonds with a smattering of cash, real estate, or alternative assets. 

Imagine Bobby B. He’s 42 years old and hopes to retire in 25 years. He and his partner make a comfortable living, contribute to their retirement accounts, and rent their spare bedroom to supplement their mortgage. 

Bobby’s moderate risk portfolio might look something like this:

  • 50-60% stocks
  • 30-40% bonds
  • 5-10% alternatives like dividend-paying real estate
  • 5-10% cash

Pros of a moderate-risk profile

  • Not likely to suffer huge losses during market downturns
  • Less anxiety about large losses
  • Suitable for a wide range of investors

Cons of a moderate-risk profile

  • May see smaller gains than high-risk investors
  • May have to invest longer to meet large goals (retirement, buying a house, etc.)

Low risk tolerance

Is your risk tolerance low?

Conservative investors are risk-averse. They aim to preserve their capital, generate income, and experience little to no volatility. Avoiding losses is the name of the game, as many of these investors rely on their portfolios to fund their lifestyles. 

You might have a low risk tolerance if you’re:

  • An older or retired investor (mid-50s and above)
  • Less comfortable financially
  • Unwilling to risk your capital
  • Chasing income and safety over growth 

Low risk tolerance example

Investors with low risk tolerance focus on generating income from their portfolios. They prefer income-producing assets like bonds, Treasuries, CDs, and high-yield savings accounts. Some may dabble in a handful of stocks (particularly dividend-paying stocks) to maintain limited growth potential.  

Imagine Cassie C. She’s 60 years old and hopes to retire in the next 7 years. She earns a comfortable income and owns her home, but she knows her retirement will have to supplement 60-70% of her pre-retirement income. She owns no rental properties. 

As an investor with a very low risk tolerance, Cassie’s portfolio might look like this:

  • 70-80% bonds
  • 5-10% stocks
  • 10-20% cash
  • 1-5% alternatives like precious metals

Pros of a low-risk profile

  • Avoids most to all risk of loss
  • Many “safe” assets offer FDIC/NCUA deposit insurance
  • Generate income to save or supplement lifestyle

Cons of a low-risk profile

  • Low long-term returns
  • Generating high income requires owning a lot of assets already
  • Selling high-risk assets to move to low-risk assets might trigger taxes

Putting it all together

None of these sample portfolios should be considered investment advice — the right portfolio for you depends on your personal needs, goals, and finances. But recognizing your risk tolerance can help you make investment decisions that serve all 3 — meeting your needs, achieving your goals, and protecting your financial position.

To do that, you need to maintain the right mix of investments. That means tracking them all — from your 401(k) to your private equity. 

Are you ready? 

Start right here.

Manage your portfolio with confidence.