Your capacity to endure risks may be at odds with your tolerance (or appetite) for risk. That’s because risk capacity, your ability to endure a drop in portfolio value without undergoing a substantial decline to your standard of living is different from the amount of risk you feel comfortable with. In other words, while you may be comfortable with an aggressive asset allocation your portfolio may be less able (the capacity) to support your desired standard of living in a down market.
Research suggests risk capacity is highest before retirement and decreases during retirement. This makes sense because when you’re saving for retirement, poor market returns can be offset by either increased savings to bolster the portfolio or working longer to give the portfolio more time to recover from a down market. In retirement, the options are more limited because retirees may find it difficult to return to the workforce as a result of reduced employment opportunities to earn income to counter (save more or delay retirement) market losses.
Risk capacity often gets overlooked. That’s unfortunate because in retirement your capacity to endure risk becomes more important than your tolerance (appetite) for risk. Knowing the difference between the two and how you decide to position your portfolio can be a crucial factor in a satisfying and stress-free retirement.
Do you know your risk capacity and how it can impact spending in retirement?
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