By Philippa Billings, Head of Advice, Otivo
Everyone's risk tolerance is high in a rising market. The honest measurement happens somewhere else entirely — at 2am during a real downturn, statement open, balance down 20 percent, with a voice suggesting that selling now would at least stop the falling. What a person does in that hour determines their investment outcomes more than almost any selection decision they'll ever make, because the biggest destroyer of long-run returns isn't choosing wrong assets — it's abandoning right ones at the worst possible moment. Which makes knowing your actual tolerance, before the 2am hour arrives, one of investing's most valuable pieces of self-knowledge.
Risk tolerance is how much investment volatility a person can genuinely endure without abandoning their strategy. It combines two factors — capacity, set by objective circumstances like timeframe and financial buffers, and temperament, the emotional response to seeing losses. A portfolio exceeding either one tends to get sold in downturns, converting temporary falls into permanent losses.
What are the two ingredients of risk tolerance?
Capacity and temperament — one about the situation, one about the person, and both binding.
Capacity is objective. Money needed in two years has no business riding the sharemarket, whatever its owner's courage — there may not be time to recover from a fall before the money is due. Money for a retirement three decades away can weather multiple full market cycles, and history's downturns have so far been temporary for investors who could wait them out. Capacity is also set by the ground beneath the portfolio — an emergency buffer and manageable debts mean a downturn never forces a sale; their absence means the market's schedule and the household's needs can collide at the bottom.
Temperament is subjective and stubbornly real. Two people with identical finances can respond to the same 20 percent fall in opposite ways — one shrugs and continues the monthly purchases, the other loses sleep, checks the balance hourly, and eventually sells to make the feeling stop. Neither response is irrational as an experience, but the second has a price — selling in the trough and re-entering after recovery is the round trip that permanently converts a paper loss into a real one. ASIC's MoneySmart risk guidance treats this behavioural dimension as seriously as the arithmetic, for good reason.
The binding rule — a portfolio must fit inside both limits. Capacity without temperament produces panic selling; temperament without capacity produces gambles with next year's money. The smaller of the two is the real tolerance.
How does someone audit their tolerance honestly?
Not with imagination — imagined losses cost nothing, which is why questionnaire courage runs high. Four questions get closer to the truth.
- What's the real timeline? Not the goal's label but the date money would actually be withdrawn — the single largest determinant of capacity.
- What happened last time? Anyone invested through a past downturn owns a data point better than any hypothetical — did they hold, buy, or sell, and how did the months feel? Behaviour under fire outweighs stated intentions.
- What does the fall look like in dollars? Percentages anaesthetise. A 25 percent fall on $200,000 is $50,000 — reading the loss in dollars, against the years of saving it represents, previews the 2am feeling far more accurately than any slider on a form.
- How often is the balance checked? Compulsive checking amplifies volatility's emotional cost — the same portfolio produces more distress at daily resolution than yearly. Checking habits are both a symptom of temperament and, usefully, an adjustable input.
How does tolerance translate into a portfolio?
Through the growth-defensive mix — the share of a portfolio in growth assets like shares versus steadier ones like bonds and cash, which sets both the long-run engine and the size of the swings along the way. Higher tolerance supports a growthier mix and its historically higher long-run returns; lower tolerance points to a steadier mix whose smaller drawdowns a person can actually hold through. The unfashionable insight is that the steadier mix can win in practice — a moderate portfolio held for thirty years beats an aggressive one sold in year six, every time it happens.
Diversification is the other half of the machinery — spreading across the four layers moderates the swings any single failure can cause, effectively buying back some tolerance for free. INTERNAL-LINK-PLACEHOLDER — link diversification article when published. And for most Australians, the largest expression of this whole decision already exists — the super investment option, where growth, balanced, and conservative settings are precisely tolerance translated into a default that most members never examined. INTERNAL-LINK-PLACEHOLDER — link super investment options article when published.
Does risk tolerance change over a lifetime?
Both ingredients move. Capacity typically falls as goals approach — the thirty-year horizon becomes five, and the mix that suited the distance stops suiting the arrival, which is why reviewing settings around life transitions matters more than reviewing them around market news. Temperament moves the other way for many people — downturns survived build genuine calluses, and the second crash generally frightens less than the first.
What shouldn't move the settings is the market's mood — tolerance revised upward in booms and downward in crashes isn't self-knowledge, it's the panic cycle wearing a questionnaire. The stable version is set deliberately, matched to actual age, timeline, and temperament, and revisited on life's schedule rather than the market's. Inside super, that's exactly the assessment Otivo's investment options module performs — weighing a member's age, current option, historical returns, and fees as regulated advice under AFSL and Australian Credit Licence No. 485665. INTERNAL-LINK-PLACEHOLDER — confirm super investment options module URL.
Frequently asked questions
Is low risk tolerance a weakness for an investor?
No — unacknowledged tolerance is the weakness. An honest conservative investor who holds a steady portfolio for decades outperforms an aspirational aggressive one who sells in the first serious fall. The strategy that survives its owner is the strong one.
Can risk tolerance be increased?
Somewhat, through structure and exposure — deeper buffers and diversification raise capacity, while experience of survived downturns, longer checking intervals, and understanding volatility as the admission price of long-run returns all steady temperament. It moves slowly, which is why portfolios should fit the current person, not the hoped-for one.
What if partners in a household have different risk tolerances?
Common, and workable — the portfolio serving a shared goal generally needs to fit the more cautious partner's genuine limit, since either partner's panic can end the strategy. Separate goals can carry separately fitted settings.
Sources
- ASIC MoneySmart — Understanding investment risk. moneysmart.gov.au/how-to-invest/risk-and-return
- ASIC MoneySmart — Choose your investments. moneysmart.gov.au/how-to-invest/choose-your-investments
- ASIC MoneySmart — Super investment options. moneysmart.gov.au/how-super-works/super-investment-options
Disclaimer
The information in this communication is current as at July 2026 and has been prepared by Otivo Pty Ltd ABN 47 602 457 732, AFSL and Australian Credit Licence No. 485665. This content is general information only and has been prepared without taking into account your objectives, financial situation or needs. It is not personal financial or taxation advice and should not be relied on as such. Before acting on any information, you should consider its appropriateness having regard to your personal circumstances. This material must not be reproduced in whole or in part, or posted on any social media platform, without the prior written consent of Otivo Pty Ltd.