Risk Tolerance vs. Risk Capacity: What Levers to Pull Depending on the Situation

How to Determine Your Risk Plan

1. Start with stability: Build your reserve and liquidity base

Before you deploy a dollar, build six to 12 months of reserves in cash or cash-like assets. Here are some potential venues:

• High-yield savings accounts (HYSA)
• Money market accounts
• Certificates of deposit (CDs)
• Cash value life insurance

These reserves increase your risk capacity—your ability to absorb financial shocks without derailing your goals.

Pro tip: The closer you are to retirement, the more important it is to increase reserves closer to 12 to 24 months and shift your portfolio toward predictable cash flow investments. This protects against the sequence of return risk—the risk of withdrawing from volatile investments during a market downturn.

2. Define and align risk tolerance vs. risk capacity

Risk tolerance isn’t just a gut feeling; it’s shaped by a mix of psychological, experiential, and situational factors. Key elements that influence an investor’s risk tolerance include:

• Investment objectives: Your goals—whether income, growth, or preservation—affect your comfort with risk.
• Time horizon: The longer your timeline, the more volatility you can generally withstand.
• Life stage and age: Younger investors tend to tolerate more risk; older investors may prioritize preservation.
• Experience and education: Confidence increases with familiarity; beginners often misjudge risk due to lack of exposure.
• Emotional response to loss: Some investors panic during downturns, while others manage to stay calm. Understanding your own bias here is crucial.

Overlay these factors with your actual risk capacity:

• Income stability and sources: How steady and diversified is your income?
• Assets and liabilities: What you own versus what you owe
• Liquidity and access to cash: Can you get to your money quickly?
• Dependents and ongoing obligations: Who relies on you financially? What financial obligations do you have in the next five to seven years?

When you align your defined risk tolerance with your actual risk capacity, you can make smarter, more resilient decisions.

3. Solve the risk alignment equation

Let’s bring this to life with a real-world example.

Investor A invested $100K into a value-add multifamily deal—10% of their total net worth. For two years, they received solid cash flow. But in year three, expenses spiked, and a natural disaster stalled operations. Distributions paused, the project became capital-constrained, and a sale was delayed. That $100K was locked up and at risk.

But here’s the key: Investor A’s risk tolerance said they were fine investing $100K. Their risk capacity, however, indicated they shouldn’t exceed $50K in any one deal (5% of net worth). Had they honored that threshold, the situation would’ve been stressful, but not destabilizing.

Bottom line: Your real estate portfolio should be designed at the intersection of what you can handle emotionally and what you can afford financially. This is where most investors go wrong: They invest based on confidence, not capacity. 

The result? Unnecessary stress, impaired liquidity, and lost momentum (this is what I focus my client work on: how to uncover misalignments, reduce stress, and pivot into smarter, cash flow-aligned strategies).

To help prevent this, use the Risk Alignment Matrix—a simple tool to categorize your current risk posture:

Risk Tolerance	Risk Capacity	Investor Profile
High	High	Growth-oriented strategist
High	Low	Growth-oriented optimist (highest potential for misalignment)
Low	High	Conservative builder
Low	Low	Builder, rebuilder, or stabilizer

Ask yourself:

• Which quadrant are you currently in?
• Is your portfolio aligned or stretched?
• What changes can you make to reduce misalignment?

Let’s now explore how to turn this awareness into action and build an aligned investment structure. Then, use a tiered model to structure your investment mix.

4. Build and maintain your investment structure

Once your reserves are set and your risk profile is clear, the next step is to intentionally deploy capital. Use this tiered structure to allocate across risk-adjusted asset classes and revisit it as your circumstances evolve:

Tier 1: Predictable cash flow investments

• Secured notes
• First-position debt funds
• If you have more time and risk capacity:
  • Secured second-position or promissory notes 
  • Dividend-producing equities

Tier 2: Personally owned assets

• Real estate assets you control directly (single-family rentals, short-term rentals, etc.)
• If you have more time and risk capacity:
  • Private businesses

Tier 3: Growth-focused assets

• Common equity in syndications
• Public stocks and bonds
• High-upside, longer-hold assets

Start conservatively. As your investing confidence and capacity grow, you can shift toward more growth-focused opportunities.

Final Thoughts

You now understand the difference between risk tolerance and risk capacity—and why alignment between the two is critical. You’ve seen how missteps can create unnecessary stress, stall progress, and put your wealth at risk. And you’ve been given a clear framework to start evaluating your investments through a smarter lens.

But knowing what to do and doing it consistently are two different things. Most investors struggle here, not because they’re inexperienced, but because they lack a clear system, ongoing accountability, and objective feedback.

Your Risk Alignment Map isn’t a one-and-done. It should evolve as your goals shift, your portfolio grows, and market conditions change. That means:

• Reviewing your reserves
• Rebalancing your allocations
• Avoiding overexposure
• Tracking your performance and progress

If you’re ready to get proactive and take control of your plan, I can help. DM me directly, and let’s build your risk-aligned strategy, so your next investment is the right one.