Key takeaways

• Risk can mean opportunity and the possibility of maximizing your returns, but it also goes hand in hand with being able to tolerate the potential for losses
• In general, the longer your time horizon, the more risk you can take — since you'll have time to recover from market downturns
• Knowing how to determine your risk tolerance is key to building an investment strategy you can stick with

One of the biggest factors in building an investment strategy is understanding your comfort level with market volatility — also known as your risk tolerance.

Risk tolerance refers to how much uncertainty or potential loss you're willing to accept when making investment decisions. Knowing how to determine your risk tolerance can help ensure your investment portfolio aligns with your long-term goals, emotional comfort, and financial timeline.

What is risk tolerance?

Risk tolerance is the amount of loss you're willing to accept when making investment decisions. It reflects your emotional and psychological ability to handle the ups and downs of the market. In economics and investing, risk tolerance is defined as the amount of market fluctuation you can endure without changing your financial plan.

This is different from risk capacity, which measures your financial ability to endure potential losses. While risk tolerance is about mindset, risk capacity is about your balance sheet, dependents, and short-term financial needs. Your general attitudes toward risk may remain consistent for much of your life, but it’s likely that your capacity for risk will change as your financial picture changes.

“Risk tolerance is rooted in your emotional response to uncertainty,” says Ryan Deakins, Senior Financial Advisor and Planner at Empower. “Capacity, on the other hand, could have more to do with your actual financial balance sheet, family needs, or short-term goals that may be affected by a higher risk portfolio.”

When do you typically have the highest risk tolerance?

Most people tend to have the highest investment risk tolerance earlier in life — often in their 20s and 30s — when their goals are long-term and they have more time to recover from market losses.

For example, retirement investments can generally be invested more aggressively during your younger years as the market will fluctuate over time. It’s important to remember that markets are cyclical — while past performance does not guarantee future results, history has shown that volatility is standard when investing and that financial markets have typically recovered over the long term.

In contrast, if you’re pursuing a short-term goal, or if you’re nearing the point where your goal needs to become a reality, you may want to take on less risk and focus on maintaining what you have. For example, if you plan to use a portion of your investments in case of emergency, your capacity to risk and willingness to tolerate loss would be much lower. 

Read more: Average asset allocation by age

How to determine your risk tolerance

Knowing how to determine your risk tolerance is key to building an investment strategy you can stick with. Your age, timeline, goals, and emotional comfort with volatility all play a role in understanding your risk profile.

Here are a few guiding questions:

• How soon will you need to access the money you're investing?
• Could you stay the course if your portfolio dropped 20%?
• Are you investing for retirement, education, or a short-term goal?

In general, the longer your time horizon, the more risk you can take, since you'll have time to recover from market downturns. Short-term goals usually call for more conservative strategies. This distinction is crucial when thinking about risk tolerance in investing.

If you have existing investments, Empower’s free Investment Checkup tool can help you assess your portfolio risk and suggest alternative asset allocations based on your risk tolerance.

Risk tolerance quiz

If you’re not sure how to calculate risk tolerance, start with this simple 3-step quiz:

Step 1: Review the three statements below and rate them on a scale from 1 (Disagree) to 5 (Agree):

• I have a good understanding of the relationship between investment risk and return. I am generally comfortable taking a greater amount of risk with my investment portfolio in exchange for higher potential returns.
• If one of my portfolios dropped 20% in value over six months due to stock market fluctuation, I would keep that portfolio, expecting it to recover its value.
• I have significant assets outside of this account that I can rely on for my future retirement needs.  

Step 2: Add up the numbers you selected for each statement to determine your risk tolerance score.

Step 3: Find your score below to help determine your approach:

Dark blue: Conservative

Medium blue: Moderate

Light blue: Aggressive

You may have a different level of risk tolerance for different goals with different timelines. For example, you may fall into the “Conservative” bracket for goals within the next 5 years but be “Aggressive” when it comes to long-term goals 20+ years from now. 

For illustrative purposes only.*

What risk tolerance means for your investment strategy

Investing your money in different asset classes can help you balance your portfolio based on your risk tolerance and when you plan to retire. Different asset types carry different levels of risk and return potential, which is why understanding your investment risk tolerance is so important.

Asset types and risk

• Fixed income: Assets that can generally offer more stability and lower risk, such as money market deposit accounts, money market funds, and bonds. When you purchase a bond, you lend money to the issuer (such as the government or a company) and earn a specified rate of interest.
• Equities: Stocks or shares in the ownership of a company that represents a claim on the company’s assets and earnings. These typically offer higher growth potential but come with more volatility.
• Cash: Liquid funds, such as those in a savings or checking account, primarily used for an emergency fund or short-term needs.

Read more: 10 varying investments to consider

Portfolio allocation examples by risk tolerance

Different risk tolerance levels generally align with different portfolio mixes:

• Conservative portfolio: 60% Fixed income allocation, 40% equity allocation. Suitable for investors who are comfortable with investments that have lower risk and potentially lower returns.
• Moderate portfolio: 40% Fixed income allocation, 60% equity allocation. Suitable for investors who are comfortable with some volatility. This mix is a balance between lower- and higher-risk investments. The risk-and-return potential is greater than with the conservative mix, but less than with the aggressive mix.
• Aggressive portfolio: 22% Fixed income allocation, 78% equity allocation. Suitable for investors who are comfortable with investments that have higher risk and potentially higher returns.

For illustrative purposes only.*

As your financial picture changes — such as getting closer to retirement or completing a big purchase — your risk tolerance level may shift. Revisiting your allocation and potentially rebalancing your portfolio helps ensure your strategy stays aligned with both your mindset and your objectives.

Cash and risk tolerance

What about cash? Empower research shows that 49% of Americans believe cash is king and feel safer holding dollars versus other investments. While building a thoughtful emergency fund with cash is highly recommended due to its liquidity, holding too much cash comes with its own risks. While you won’t lose dollars holding cash, you can miss out on potentially greater returns through investing and compound earnings, and lose significant spending power. This is especially relevant for those with a high tolerance for risk who want their money working harder.

Read more: Understanding compound interest and its power

The bottom line

Aligning the level of risk in your portfolio with your goals depends on both your willingness to take risk and how much time you have left to save. If deciding your risk tolerance alone feels risky, a financial professional can help you ensure the level of risk in your portfolio aligns with your ability to handle a market downturn.