We all know what it feels like to make an emotional decision. Maybe you bought something expensive on impulse or sold an investment after watching the market drop for three straight days. Rarely do those emotion-driven decisions age well.
Yet, in financial planning, we’ve institutionalized the idea of building entire investment strategies on how we “feel” about risk — something called risk tolerance. We give it questionnaires, scoring systems, and tidy categories like Conservative, Moderate, or Aggressive.
Here’s my hot take: risk tolerance is a fundamentally flawed foundation for planning. It’s widely used because it appeases regulators and compliance departments, and it makes for a nice marketing story. But as a metric for guiding real-world financial decisions, it’s often flawed.
Let me explain why...
I got into this business in 2010, when the world was still reeling from the Great Financial Crisis. Confidence in markets was fragile. Portfolios had just endured one of the worst drawdowns in modern history. People certainly weren’t feeling “risk-on.”
Back then, almost every conversation revolved around safety, preservation, and rebuilding trust. Investors stated “risk tolerance” was low — understandably. But what stood out to me was that many of those same people, years later, became very comfortable taking on more risk once markets recovered and the fear faded.
Over nearly 15 years of mostly “up-only” markets, we’ve watched investor psychology flip: from fear and caution to optimism and exuberance. This may sound anecdotal, so I actually took the time to go back and review risk assessments from 2010 from our clients, and the evidence overwhelmingly showed how much risk tolerance has changed in the last 15 years.
It’s made me realize just how unstable and context-dependent “risk tolerance” really is.
The 2 Pillars of Risk Tolerance
Risk tolerance can be broken down into 2 components:
- Willingnessto take risk is emotional — how much volatility and loss you can stomach without panicking.
- Ability to take risk is financial — how much can you afford to lose before it jeopardizes your goals.
In theory, both should matter. In practice, however, most plans give far more weight to willingness. And that’s where the problem begins.
How Did We Get Here?
1. It’s a compliance and regulatory checkbox
Like all wealth management firms, we have each new prospective client complete a risk assessment questionnaire. This is absolutely necessary for compliance and fiduciary management, while providing invaluable information that serves as a great starting point for discussing risk and future expectations. However, it's crucial to recognize that risk tolerance isn't static; it's dynamic and shifts with market conditions. That's why we view it as an ever-evolving conversation that should be revisited year after year.
2. It makes for great marketing
“Find your investor personality” sounds engaging. It gives clients a label and a sense of control. But that simplicity comes at the cost of accuracy. True financial resilience can’t be captured by a seven-question quiz.
3. It assumes emotions are stable
They’re not. When markets are calm, most people claim to have a greater willingness to take risks. When volatility spikes, that willingness evaporates. A plan built primarily on emotional comfort is built on shifting sand.
4. It creates an illusion of precision
Turning feelings into a numerical score (like “risk level 4 of 7”) gives a sense of scientific rigor — but there’s no universal formula linking that score to an optimal portfolio.
Why Ability Deserves Center Stage
The ability to take risks, on the other hand, is rooted in facts, not feelings. It’s defined by your time horizon, income stability, asset level, withdrawal needs, and life stage. It doesn’t fluctuate with ups and downs in the market or sentiment.
When we start with capacity — what a family can afford to lose without derailing their plan — we establish durable boundaries. Then, within those limits, we can adjust for willingness.
In other words:
Ability sets a max on risk. Willingness determines how close to the max we’ll go.
Building Better Plans
Here’s how I believe the process should work:
- Start with capacity modeling.
Measure cash flow durability, liquidity, and stress scenarios first. What happens if markets drop 20%? 30%? Can the plan survive? - Use tolerance as a secondary input.
Understand emotions, but don’t let them drive the bus. Align comfort with capacity, not the other way around. - Revisit regularly.
Just as life changes, so do emotions. A good plan adapts to both — but it’s anchored in math, not mood. - Continuous education.
The best way to strengthen “tolerance” is through knowledge. When clients understand volatility and recovery cycles, fear loses much of its power.
Why It Matters
From 2010 through 2020, investors experienced one of the most generous stretches in market history. It was an era defined by cheap money, low inflation, and regular all time highs. With the exception of a few brief pullbacks, portfolios largely went one direction — higher.
Then came 2023 and 2024 — two years that looked eerily similar to the late 1990s. We saw back-to-back years of 20%+ returns, and 2025 on track to end right around 20%. That kind of performance naturally fuels confidence. It also awakens something dangerous: greed.
Investing has always been a battle between fear and greed — the two strongest emotional forces in finance. Fear whispers, “Get out before it’s too late.” Greed urges, “Don’t stop now — there’s more to be made.” Both voices are loudest at precisely the wrong times.
The devil on your shoulder will always say, “More, more, more.” And when markets eventually wobble, fear will tell you to do the opposite — “Sell before it’s all gone.”
When is an emotional decision ever a good idea? Almost never — and that includes how we approach investing.
Here at Richard W. Paul & Associates, we believe strong plans are built on ability first, willingness second — because emotions change, but your long-term goals shouldn’t.
Disclosures
This material has been prepared for informational purposes only and should not be construed as a solicitation to effect, or attempt to effect, either transactions in securities or the rendering of personalized investment advice. This material is not intended to provide, and should not be relied on for tax, legal, investment, accounting, or other financial advice. You should consult your own tax, legal, financial, and accounting advisors before engaging in any transaction. Asset allocation and diversification do not guarantee a profit or protect against a loss. All references to potential future developments or outcomes are strictly the views and opinions of Richard W. Paul & Associates and in no way promise, guarantee, or seek to predict with any certainty what may or may not occur in various economies and investment markets. Past performance is not necessarily indicative of future performance.