Investing may feel like a balancing act between the thrill of potential growth and the anxiety of potential loss.

At the heart of this ebb and flow lies a concept called risk tolerance. This represents the level of market volatility you can handle without taking on excess anxiety or endangering your fiscal health. (Risk tolerance is distinct from risk capacity, which reflects how much financial loss you can realistically absorb.) Finding your optimal balance ensures that you remain committed to your financial plan, even when the market enters a rough patch.

To gauge your personal risk tolerance, look beyond the numbers and evaluate your timeline, emotions, and current fiscal capacity.

Financial timeline

Your time horizon serves as the most objective factor in determining how much risk you can pursue. For example, a younger investor with decades until retirement may have more flexibility. You can weather several market downturns because your portfolio likely has years to recover before you need to withdraw the funds. In this scenario, you might lean toward a higher-risk, higher-reward strategy involving more traditional stocks.

Conversely, if you plan to buy a home in two years or retire next summer, your time horizon is short. A sudden market drop could significantly deplete the funds you need immediately. In these cases, a conservative approach focusing on bonds or cash equivalents may make the most sense for you.

Emotional resilience

While a financial professional might tell you that you could take on more risk, your stomach might say otherwise. This is your emotional risk tolerance. To test this, imagine checking your brokerage account and seeing a 20 percent drop in value overnight. Would you see this as a “sale” and buy more? Or would you feel a sense of panic and want to sell everything to prevent further loss?

If the thought of a market dip causes you genuine distress, you likely have a lower emotional risk tolerance. After all, investing is a marathon, not a sprint; if your portfolio causes you anxiety, you may make impulsive decisions or abandon your strategy altogether at an inopportune time. A portfolio that reflects your temperament helps you stay the course for the long haul.

Fiscal health

It is important to distinguish between how much risk you are willing to take and how much you can afford to take, or your risk capacity. Even if you have the nerves of a professional gambler, you should not take high risks if you lack a financial safety net.

Before you pursue aggressive investing, ensure that you have a robust emergency fund and stable income. For instance, if a market crash occurs at the same time you lose your job and you have no savings, you might have to sell your investments at a loss just to pay your rent. High risk capacity comes from having a solid financial foundation that protects you from life’s unexpected turns, including subpar investment performance.

Gauging your risk tolerance is not a one-time exercise. Your goals, age, and wealth will change, and your investment strategy should evolve alongside each of these. If you assess your timeline, emotions, and fiscal health honestly, you can build a portfolio that helps you pursue your long-term goals while also preserving your peace of mind.

For more assistance in finding the investment approach that works for you, speak with a financial professional.