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What's Your Risk Capacity?—And How to Use It to Help Build Your Retirement Portfolio

Saving and investing take discipline and a tenacity to stick with investments in up and down markets. But it’s another thing to be willing to accept risk when you’re in or near retirement. 

A common approach to deciding if investments or an investment mix is appropriate for you is to determine your risk tolerance. How much risk can you stomach? But there’s another way to think about risk—especially in or near retirement, or for any shorter-term investment goal. How much risk can you afford? When do you need some of your money back?

What is risk capacity?

Start with this question: Will you still be able to meet your investment objectives if your investment portfolio falls in the short term? In other words, how much can you afford to lose, and how long can you afford to wait for your investments to potentially recover?

Investments in stocks and other higher-risk instruments typically generate higher returns than lower-risk instruments, such as cash and bonds, over time. Over short time horizons, however, they can be quite volatile. If you have a long time horizon, and can weather ups and downs without selling out of the markets, time generally works to your advantage.

The shorter your time horizon, the more damaging volatility can be. If you need money soon, your capacity to take risk for a portion of your portfolio is—and should be—lower than if you don't.

How does risk capacity apply to your portfolio?

One commonly heard suggestion on what percentage of your investable assets to invest in a combination of riskier, growth-oriented assets (such as stocks) and more predictable, less growth-oriented assets (such as cash and high-quality bonds) is to take 100 minus your age and invest that percentage in stocks. Then, invest the rest in cash and bonds. That’s a fine place to start. But it’s likely too simple.

Instead, consider your needs over a short time horizon. If you're nearing retirement, think about how much money you need from your portfolio for the next two to four years. Invest that conservatively. Then invest the rest based on your longer-term time horizon and risk tolerance. In other words, work backwards to build your allocation.

By focusing on your risk capacity and the timing of when you need money, you’ve gone beyond simple suggestions. You’ve created a personalized portfolio.

Here's an example.

John and Nancy, ages 65 and 63, preparing for retirement

For simplicity of the math, let's assume that John and Nancy have $1,000,000 in investments for retirement. These investments are held in a combination of a brokerage account and a traditional IRA account.

John and Nancy would like to spend $50,000 per year from their investments. They expect to get $25,000 per year from Social Security and other income sources. That gives them a total desired “paycheck” of $75,000 annually, not factoring in taxes, in the first few years of retirement.

John and Nancy review their thinking about investing and start first with their risk capacity. Recall, after one year of withdrawals needed in cash, we suggested a roughly two- to three-year allocation to relatively stable investments—short-term bonds for example—as a foundation before taking more investment risk.

For John and Nancy, a three-year projection of this need is $50,000 times three years, or $150,000 (15% of their portfolio) in cash investments and short-term bonds, using either a short-term bond fund or high-quality bonds or CDs with maturities in one to two years. That leaves $850,000 (85%) for other investments.  

Keep in mind, this is an illustration and simplification. John and Nancy should work with an advisor to determine if $50,000 a year, or some other amount, is a sustainable amount to spend from their portfolio based on their life expectancy, risk tolerance and other details. And the amounts for current-year spending and a short-term reserve would likely need to increase over time with inflation.

A sample portfolio to address John and Nancy’s needs

Asset class Amount ($) Amount ($) Purpose

Cash investments



Current spending

Short-term bonds



Short-term reserve

Intermediate-term bonds



Capital preservation and income

U.S. stocks



Growth and income

International stocks



Growth and income




All retirement assets

Source: Schwab Center for Financial Research. For illustrative purposes only. For fund ideas see the Schwab Mutual Fund Portfolio Builder tool or Schwab Mutual Fund or ETF Select Lists.

This portfolio contains roughly 60% in higher-risk investments—including a small allocation to high-yield bonds—and 35% bonds and 5% in cash. Depending on their risk tolerance, the portfolio above is a sound place for John and Nancy to start, based on their short-term needs but also their long-term objectives to generate investment income and likely grow their portfolio to fund the later years of retirement.

As retirement progresses, John and Nancy may find that their spending needs change. If or when this happens, they can adjust their allocation to stocks and cash investments and bonds. This mix of investments also happens to be about what we would suggest for the average investor at or near retirement planning to spend between 4% and 5% of their portfolio annually, not including taxes in the first year of retirement.

Why should investors approaching retirement add a two- to three-year investment cushion?

Based on previous market performance, having a financial cushion designed to last three to four years can increase confidence and makes sense for most investors getting close to or living in retirement. This could include a year in cash for spending and a two- to three-year reserve in short-term bonds. Over the past 50 years, the average bear market for U.S. stocks lasted a little more than one year, and the time it took the S&P 500® Index to recover to prior highs was about three and a half years. Exactly how much you allocate to cash and short-term bonds can vary based on your risk tolerance.

Time to recovery of a market decline


Peak to trough decline of the S&P 500

Recovery date

Time to recovery

February 1966 to October 1966


May 1967 

1 year 3 months

November 1968 to May 1970


March 1972

3 years 6 months

January 1973 to October 1974


July 1980

7 years 7 months

November 1980 to August 1982


November 1982

2 years

August 1987 to December 1987


July 1989

1 year 11 months

July 1990 to October 1990


February 1991

7 months

March 2000 to October 2002


June 2007

7 years 3 months

October 2007 to March 2009


March 2013

5 years 5 months




3 years 2 months

Source: Schwab Center for Financial Research with data provided by Bloomberg. The table shows where the S&P 500 fell 20% or more over a period of at least three months. Past performance does not guarantee future results.

Note that the table above shows the “time to recovery” of the S&P 500 index. We do not recommend a portfolio based exclusively on this index. The time to recovery for assets held in a diversified portfolio would likely have been shorter—not considering withdrawals, if any, from the portfolio.

If you want a more personalized approach to asset allocation, consider what you will need soon and your capacity. How much risk can you afford to take over two to four years—about the time to weather a bear market? Then you could consider investing the rest based on other factors—such as your time horizon, growth objectives and risk tolerance.

What You Can Do Next

Important Disclosures


The information here is for general informational purposes only and should not be considered personalized investment advice. The type of securities and investment strategies mentioned may not be suitable for everyone. Each investor needs to review a security transaction for his or her own particular situation.


Investing involves risk, including loss of principal.



