Opportunity, Meet Preparation
A few weeks ago, I had the opportunity to attend Financial Planning Magazine’s Advise | AI conference in Las Vegas. While I learned a great deal about the application and risks of AI in financial advice, what really got me thinking on my trip was an activity Las Vegas is famous for—gambling. Whether it’s pulling the lever on a slot machine, betting on a blackjack hand, or channeling your inner James Bond at a baccarat table, the allure of risk is ever-present in Vegas.
It’s no coincidence that casinos are designed to keep you playing. The environment is carefully curated to inhibit our brain’s ability to access higher-level thinking and accurately assess risk. Our brains, specifically the amygdala, are wired for quick risk assessments—the kind that kept our prehistoric ancestors alive. Think: “There’s a sabretooth tiger at the mouth of the cave; what do I do?” Fast, instinctive decisions were essential for survival.
However, financial decisions require a different approach. Questions like, “I just won a hand—should I cash out or go for more?” or “How much international equity should I hold in my portfolio?” are far more complex and don’t lend themselves to snap judgments. That’s where a thoughtful discussion about risk tolerance comes into play, ideally with the guidance of an external party like a financial advisor.
When we talk about portfolio risk, the conversation typically centers on a person’s tolerance for risk. This is the “jump out of an airplane” analogy: some people thrive on adrenaline, while others prefer to keep both feet on solid ground. In the context of investing, risk tolerance refers to how you feel about market volatility and potential losses. Can you ride out the ups and downs, or do market swings make you nervous?
Interestingly, many investors don’t fully understand their own risk tolerance. For example, I’ve met self-proclaimed conservative investors with portfolios that tell a different story—hello, Bitcoin enthusiasts! This disconnect between perceived and actual risk tolerance can lead to portfolios that are misaligned with an investor’s comfort level, which often results in panic selling during market downturns.
But risk tolerance is only part of the equation. Another key factor is risk capacity, which has nothing to do with how you feel about risk and everything to do with how much risk you can afford to take. Your capacity to take on risk depends on factors like how long you have before you need access to your investments, your income level, and the size of your portfolio.
If you have a long time horizon or a substantial safety net, your risk capacity is higher—you can afford to weather market fluctuations. Conversely, if you’re in a situation where you need to make significant withdrawals soon, your capacity to take risk is lower, even if you’re comfortable with risk in general.
Finally, your financial plan plays a critical role in determining the right level of risk. Your portfolio’s growth projections and overall performance are based on the amount of risk you take. The reason investors are rewarded with returns is that they’re taking on some level of risk—if there were no risk, there’d be no reward.
Portfolio performance is a key variable in determining whether your financial plan succeeds. To create a well-rounded risk profile, you need to balance how you feel about risk (risk tolerance), how much risk you can afford (risk capacity), and the performance goals tied to your financial plan. These three elements work together to inform the “right” level of risk for your portfolio.
Crafting a portfolio isn’t about taking unnecessary gambles; it’s about making informed, deliberate choices based on your unique risk profile. Sure, in Las Vegas, the thrill of gambling is part of the appeal, but you can’t ignore the fact that casinos aren’t designed to lose money—the house always wins in the long run. In investing, however, you’re not playing against the house. By carefully balancing your risk tolerance, risk capacity, and financial goals, you can stack the odds in your favor.
Take the time to assess these key elements thoughtfully and seek the guidance of a financial advisor when necessary. When you understand how these factors influence your portfolio, you’re no longer gambling—you’re investing in your future with confidence.
