Retirement and Risk: The Difference Between Tolerance and Capacity

Maintaining the balance
The timing of investment strategies can affect the relationship between tolerance and capacity. Consider the following examples.

  • Early planners: When you have three or four decades between now and your anticipated retirement age, your tolerance can typically stand to be higher. Even if you take a moderate loss early on, you have plenty of time to recover; you’re not so close to retirement that capacity is creating the sort of pressure that it will in coming years. However, if you find you’re a low-tolerance investor, keep in mind that a bond-heavy portfolio won’t build a cushy retirement account like a stock-dominated portfolio could.
  • Mid-career planners: For planners whose working life has entered the middle phase, approaches to risk might change. Even if your tolerance is high — i.e., if you like to shoot for high returns even if you take more significant losses along the way — the realities of your financial situation could mean that you should reduce your risk somewhat. A married mother of three and a freelance artist might not be able to tolerate as much risk as, say, a single woman who got ahead with her start-up’s well-timed IPO. For the average mid-career retirement planner, capacity may dictate a process of steadily reducing portfolio risk.
  • Flush or frugal? As you approach retirement, the relationship between your capacity and assets will largely determine how you create and maintain your fixed income. If you end your career a billionaire, then congratulations: Even if the risk you take exceeds your capacity, and even if you take a loss because that risk doesn’t pay off, you’ll likely still have the liquidity to keep up car payments, mortgage payments, and the like. However, if you’re a more typical retiree, tolerance and capacity will likely play a more delicate role in your decisions. For example, when it comes to this type of retiree, experts at Schwab recommend a portfolio along the lines of 40% cash-and-bonds coupled with 60% stocks (their proposal is predicated upon a $1 million retirement account fueling $50,000 in annual income).
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