Understanding Risk Tolerance: The Financial Assessment Every Retiree Needs

“You can’t handle the truth.” That famous line from A Few Good Men sums up how many investors think about risk. Most believe they can handle volatility, until a 20% or 30% market drop tests their nerves.

In a recent Conquering Retirement episode, Tom and Brian Hamlin tackled a listener’s question about risk tolerance and why it matters so much in retirement planning. Their answer went beyond definitions. 

Understanding your true comfort with risk isn’t just helpful; it can be the difference between staying invested and making emotional, costly mistakes.

Beyond the Mic: What Risk Tolerance Really Measures

Risk tolerance isn’t about being fearless or cautious. It’s about knowing how much market decline you can handle before you start losing sleep.

Think back to 2022, when the market fell around 20%. Or 2008, when the S&P 500 dropped more than 35%. If a dip like that would make you want to sell, your portfolio might not match your comfort level, and that’s when people make the most expensive mistakes.

Most risk questionnaires label investors as “conservative,” “moderate,” or “aggressive,” but those words don’t mean much on their own. Our firm uses a 1 to 99 scale instead, where 1 represents cash and 72 represents the average stock market. It’s a simple way to see where you fall and how that compares to your actual investments.

Here’s the twist: playing it too safe can also be risky. If you plan to take regular withdrawals in retirement, you still need some growth to outpace inflation. Over time, stocks have historically helped preserve purchasing power better than fixed income alone. The goal is to strike a balance between growth and stability, ensuring we can keep up while staying comfortable.

The Hidden Risks Most Retirees Miss

When most people think of “risk,” they picture stock market swings. But several kinds of risk can quietly impact your plan:

• Market Risk: The ups and downs of stock prices.
• Inflation Risk: The slow erosion of your purchasing power. Even if your portfolio feels “safe,” inflation can chip away at it year after year.
• Liquidity Risk: Not having easy access to your money when you need it, which is more common with certain annuities or real estate investments.
• Interest Rate Risk: The impact of changing interest rates on bonds and fixed-income assets.

The key takeaway: avoiding market risk doesn’t mean avoiding risk entirely. You may simply trade market risk for inflation risk, and that can be even more dangerous over time.

Practical Strategies for Managing Risk

• 1. Take both versions of a risk assessment.
  A quick one gives you a baseline, and a detailed version dives deeper. If the results differ, that gap shows how self-aware you are about your comfort level.
• 2. Diversify by time horizon, not just asset class.
  Think of your portfolio like preparing for a long winter. You need short-term “supplies”, a safe asset that covers expenses when markets drop. This is where annuities shine, offering steady income during down markets.
• 3. Match your investments to your score.
  If your risk score is 48, your portfolio doesn’t need every investment to match that number. You might blend higher-risk assets (like an 80-rated stock fund) with lower-risk ones (like a fixed annuity) to average out.

• 4. Avoid margin or leverage.
  Borrowing against your portfolio can backfire fast. When markets drop, losses compound and force you to sell at the worst time.
• 5. Consider structured products for downside protection.
  Tools like Registered Index-Linked Annuities (RILAs) allow you to participate in market growth while limiting losses. Some even offer features that turn small declines into modest gains over time.

Final Thoughts

Risk tolerance isn’t static. Major life changes, health shifts, or retirement itself can all affect how much volatility you’re comfortable with.

The goal isn’t to eliminate risk, it’s to spread it wisely so no single market event can derail decades of planning.

As Tom often says, “You’re a financial patient who needs regular checkups.” Revisit your risk assessment regularly, know where you stand, and build a portfolio that helps you sleep at night, while still protecting against the risks you can’t see.

Listen to the full Conquering Retirement playlist for more retirement tips and suggestions on how to set yourself up for retirement. 

Sources

• Wall Street Journal – “Playing the Right Retirement Cards” (1999) 
• Monte Carlo Simulation Theory (Historical reference – original article from 1999) 
• Historical S&P 500 Performance Data 
• Morningstar – Retirement Withdrawal Strategies