In developing financial plans for our clients, a critical component of the process is developing the asset allocation to be utilized in the construction of their portfolios. Several factors are considered when constructing those portfolios, but the risk profile of the client is perhaps the most important consideration.
Not all investors approach investment risk in the same way. Two concepts, risk tolerance and risk capacity, are helpful in determining a client’s risk profile.

Risk Tolerance: Your Emotional Comfort Zone

Risk tolerance is a psychological measure of the volatility an investor can accept without abandoning their asset allocation. Some people can shrug off a bad week in the stock market, while others get anxious the moment their account balance drops.

Think of it like riding a rollercoaster. If big drops make your stomach churn, your tolerance is probably low. If you throw your hands in the air and enjoy the ride, you have higher tolerance.

Risk Capacity: Your Financial Reality

Risk capacity, on the other hand, is a financial measure of the risk an investor can afford to take, based on factors such as time horizon, cash flow, liquidity, and proximity to funding goals. It’s less about feelings and more about facts:

• Do you have steady income?
• Is retirement decades away, or just around the corner?
• Do you have cash reserves for emergencies?

A 30-year old with a long time horizon and stable income can be assumed to have a higher risk capacity. A person at that age has the time to recover wealth lost when a market downturn occurs. There is potentially less need to liquidate a stock portfolio in the down market.

On the other hand, a 60-year-old investor who is about to retire has less time to recover from that same downturn in the market—even if they have a high-risk tolerance. They are approaching the time when their portfolio will be needed to fund their retirement lifestyle.

Age, however, is not always an indicator of risk capacity. Consider a young couple saving for a downpayment on a home purchase. While their risk tolerance might be high, their capacity to take risk in the funds they are saving for the home downpayment is constrained. They will have a need for the money in a few years and will be better served by investing those funds in more conservative investment vehicles (i.e., money market funds).

Think of risk tolerance as your willingness to take risk in your investment portfolio while risk capacity is your ability to take risk considering the specific facts of your financial situation.

The above chart shows the interaction between these two elements of risk and their implications for asset allocation decisions.

• Investors in the upper left quadrant have the financial ability to take more risks, but their low comfort with volatility could lead to overly conservative portfolios that may fall short of long-term growth needs
• Investors in the lower left quadrant lack both the financial ability to take risks and the emotional willingness to tolerate volatility, making them best suited for conservative portfolios focused on capital preservation
• Investors in the lower right quadrant enjoy taking risks and may seek aggressive strategies, but their limited financial capacity makes them vulnerable to setbacks that could jeopardize key goals
• Investors in the upper right quadrant have both the means and the mindset to take risks, allowing them to pursue growth strategies that align with their long-term objectives

Risk tolerance and risk capacity are two sides of the same coin. Tolerance is about the head and heart, your psychological comfort with volatility. Capacity is about financial realities, your ability to withstand losses and still meet your financial goals.

Balancing risk tolerance and risk capacity ensures asset allocations are both sustainable and durable. Portfolios built only on “what feels right” risk shortfalls; those built only on “what the math says” risk abandonment during volatility.

Randall J. Freeman, CPA

Randy joined the firm in 2023 after a 29-year career as Chief Financial Officer at Brasfield & Gorrie, one of the nation’s largest privately held construction companies. As CFO, he was responsible for the financial management of the company, including overseeing both its corporate investment portfolio and 401(k) plan assets. Previously, he served as an audit manager in the Birmingham office of Coopers & Lybrand (now Pricewaterhouse Coopers). He holds a Bachelor of Science in Business Administration from Samford University. Randy is a member of the AICPA and ASCPA and is a past president of the Birmingham chapter of the Construction Financial Management Association. He currently serves on the Advisory Board for Samford’s Brock School of Business, is past president of the Epilepsy Foundation of North and Central Alabama and an alumnus of Leadership Birmingham (class of 2004). Randy enjoys traveling and spending time at the lake with his family.

Leavell’s Team-Based Approach to Client Relationships

At Leavell, we believe exceptional financial guidance begins with a collaborative approach. Every client is supported by a dedicated team that ensures personalized, comprehensive, and responsive service.

Each client team includes:

• Investment Counselor – Your primary advisor, focused on understanding your financial goals, risk tolerance, and long-term objectives. The Investment Counselor designs a customized investment strategy and holistic financial plan tailored to your unique needs.
• Portfolio Manager – Responsible for executing your investment strategy. The Portfolio Manager makes investment decisions, actively monitors market conditions, and adjusts portfolios to stay aligned with your goals.
• Client Service Representative – Delivers attentive, high-touch service. From account setup and document management to money movement and ongoing inquiries, your Client Service Representative ensures every detail is handled with care.

This team-based structure enables Leavell to provide well-rounded support and long-lasting client relationships built on trust, expertise, and continuity.

Important Disclosures: The statements and opinions expressed in this article are those of the authors as of the date of the article, are subject to rapid change as economic and market conditions dictate, and do not necessarily represent the views of Leavell Investment Management, Inc. This article does not constitute investment advice, is not predictive of future performance, and should not be construed as an offer to sell or a solicitation to buy any security or make an offer where otherwise unlawful. Investing in securities carries risk including the possible loss of principal. Individual circumstances vary. Past performance is no guarantee of future results.