How Much Risk Should I Take in My Investment Account?

The question of how much risk you should take in your investment account always comes back to one thing: the purpose of the account. Why does this money exist, and when will you need it?

Risk is often talked about in terms of risk tolerance, which is basically how comfortable you feel with ups and downs. The challenge is that risk tolerance is heavily tied to emotions. When markets are going up and things feel good, our tolerance for risk tends to be higher. When markets are down and headlines are negative, that tolerance tends to disappear.

That’s why portfolios shouldn’t be built solely around risk tolerance. They should be built around risk capacity — your ability to afford taking risk.

Risk capacity is driven by things like income, liquidity, and time horizon. Generally speaking, if you have a higher income, more investable assets, and a longer timeframe, you can afford to take more risk — even if you don’t feel particularly “risky.”

That’s actually my situation. I don’t have a high risk tolerance, but I do have a high risk capacity. I’m a long-term investor, I have adequate savings, and a market downturn doesn’t impact my day-to-day life. I understand that over time, markets have rewarded disciplined investors.

So how much risk should you take?
Enough to support the purpose of the account — and no more than your situation can afford.