As we settle into May 2025 here in Fairfield County, Connecticut, I’m reminded how critical it is to build a retirement plan you can stick with—no matter what the market throws your way. I’m Tony Leonardi, a CFP® professional serving clients across multiple states, and today I want to dive into a topic that’s foundational for any retirement strategy: measuring your risk tolerance. For more on how I help clients navigate these decisions, visit LeonardiFamilyWealthcare.com.
When it comes to investing, you’ve likely heard the phrase “no risk, no reward.” While there’s truth to that, taking on too much risk can lead to sleepless nights and emotional decisions that derail your financial future. On the flip side, being too conservative might mean your savings don’t grow enough to sustain a long, fulfilling retirement. So, how do you strike the right balance? Let’s break it down.
Why Risk Tolerance Matters in Retirement Planning
At its core, risk tolerance is about how much uncertainty you can handle with your investments. It’s the balance between the returns you want and the losses you can emotionally and financially endure without making rash decisions. The stock market is unpredictable—some years it surges, like last year, while others, like 2008 or 2020, it takes a dive. The real question is: how will you react when the market drops 10%, 20%, or even 40%?
Your reaction to these swings directly impacts your retirement plan’s success. As I often tell my clients, long-term investing is about time in the market, not timing the market. Understanding your risk tolerance ensures your strategy is something you can stick with, even when volatility strikes.
The Three Components of Risk Tolerance
Measuring risk tolerance isn’t just about gut feelings—it involves three key components: emotional comfort, risk affordability, and risk need. Let’s explore each one.
1. Emotional Comfort with Risk
This is what most people think of when they hear “risk tolerance.” How much market volatility can you handle before you start to worry—or worse, panic? Ask yourself: If the market dropped 20% tomorrow, what would you do? If you have a $1 million portfolio and lose $200,000 overnight, how would you react? Do you check your portfolio daily, or are you comfortable riding out the ups and downs?
Behavioral finance offers insight here through the concept of loss aversion. Studies show that people feel the pain of a loss about twice as strongly as the pleasure of an equivalent gain. Losing $100 hurts twice as much as gaining $100 feels good—and the larger the numbers, the sharper the pain. I see this with my clients: my phone rings far more when the market goes down than when it goes up. Emotional reactions, like selling after a market drop, can hurt your long-term plan. If volatility keeps you up at night, a more conservative portfolio might be the right fit. But if you understand short-term swings are part of long-term gains, you may be comfortable with more risk.
2. Risk Affordability: Can You Afford to Take the Risk?
Even if you’re emotionally okay with risk, your financial situation—what I call risk affordability—matters just as much. Consider your time horizon. If you’re in your 30s or 40s, you have decades to recover from downturns, so you can afford more risk. If you’re already retired, you might need stable income and can’t afford the same level of risk, even if you’re emotionally comfortable with market fluctuations.
Look at your savings and income sources. Do you have enough assets and cash flow to ride out market dips, or do you need predictable investments? If your fixed expenses—like housing or healthcare—are covered by fixed income sources such as Social Security or a pension, you might afford to take more risk with your portfolio. But if your investments are your primary income source, a balanced approach may be safer. Here in Fairfield County, where healthcare costs can be significant, I often see retirees prioritizing stability over aggressive growth.
3. Risk Need: What Are You Investing For?
Finally, consider your risk need—what returns do you need to make your plan work? If your goal is long-term growth and you don’t need the money for 20 years, you can afford more risk. If you’re in retirement and need consistent income, your portfolio should include stable assets like bonds or annuities alongside stocks.
Ask yourself: How much return do I need to meet my goals? If a conservative 4-5% return keeps your plan on track, there’s no need to chase higher returns—and higher risk. But if you need 7-8% to avoid running out of money, being too conservative could put your goals at risk. What happens if your required return doesn’t match your emotional comfort? You might need to adjust your plan—saving more, spending less, or even working longer. Financial modeling, a tool I use with clients, can help find the right balance.
Understanding Risk Through Volatility: The Role of Standard Deviation
More risk doesn’t always mean better results—it can actually reduce your probability of success. Why? Because higher risk means more volatility, which can lead to bigger swings in your portfolio’s value. If you’re withdrawing money in retirement and a downturn hits early, it can cause lasting damage—a snowball effect that later gains might not fix.
We can measure this volatility using a statistical tool called standard deviation. It quantifies the variation in a portfolio’s returns. A higher standard deviation means wilder fluctuations (more risk), while a lower one suggests more stable returns. For example, a portfolio with a 7% average return and a 10% standard deviation will typically see returns between -3% and 17% about 68% of the time (one standard deviation). For 95% confidence (two standard deviations), returns could range from -13% to 27%. Compare that to a portfolio with the same 7% return but a 5% standard deviation—its range is tighter, between 2% and 12% (one standard deviation), suggesting less risk.
The catch? While we can predict volatility, we can’t predict when it will happen. This is called sequence of returns risk. If the market drops 30% early in your retirement while you’re withdrawing funds, your portfolio might not recover—even if your neighbor gets the same average return but experiences volatility later. The key is balancing growth and stability to keep your plan on track.
Your Action Plan: Aligning Risk with Your Retirement Goals
Understanding your risk tolerance isn’t just about comfort—it’s about ensuring your investments align with your long-term plan. Here’s how to get started:
- Determine Your Required Rate of Return: Base this on your financial plan, not just what sounds good.
- Assess Your True Comfort with Risk: Reflect on past market downturns like 2008 or 2020—how did you react?
- Align Investments with Your Risk and Needs: Taking too much or too little risk can both be dangerous. Find the right mix.
If you’re unsure where you stand, working with a financial advisor can provide clarity. For more insights on building a retirement plan that fits your needs, visit LeonardiFamilyWealthcare.com. Whether you’re in Fairfield County or across the country, you can also listen to more episodes on my podcast channel on Spotify or Apple Podcasts, or watch related videos on my YouTube channel. For a free tool to kickstart your planning, download the 2025 Retirement Reset Checklist.