When you are trying to decide what investments you should choose for your investment strategy, there are several variables that can play a part in those choices.  Some of the main characteristics you need to address are your risk tolerance, your time horizon, and your financial goals,  .  If you can understand these three variables of your financial profile, then you can determine what types of investments you should choose for your portfolio mix.

One of the most important factors you must consider is your risk tolerance.  This is exactly what it sounds like, it’s how much risk you can handle with your investments.  It sounds simple, but when you start thinking about it, how do you determine how much you can handle? Over the years of talking to clients, this is the hardest factor to pin down with most people because what they perceive their risk tolerance to be, and their actual tolerance level tends to be completely different.  Some people see themselves as very conservative but are comfortable with a 10-20% price move.  Others may consider themselves riskier but can’t handle a 10-20% price move in their portfolio in the short term.  I’ve talked to 20-year-olds who want to be conservative, when they should be more aggressive, and I’ve talked to 60 years olds who are 100% comfortable being really aggressive.  Age doesn’t always determine your risk tolerance either.  So how would you determine your risk tolerance?  I think there is one main question you need to ask yourself and your answer should be 1 of 3 possible solutions.  The question is, how much value can my portfolio lose in the short term before I start losing sleep? At what point does it become unbearable when you see your portfolio down by a certain amount or percentage that you start to lose sleep over it because you keep thinking about it?  That’s the question you need to ask yourself.

You probably fall in one of three possible answers.

  • Limited Tolerance – You can’t handle it to be down much at all.
  • Fair Tolerance – You can handle a little bit of volatility, maybe up to a 10-15% price decline.
  • In It To Win It – You can handle major market corrections of 20% or more.

When you ask yourself this question, I would pretend you had a considerable amount of money invested.  That amount of money can differ vastly from different people, so you choose what you would consider to be a substantial amount of money,  whether its $10,000, $100,000, $1,000,000 or more.  If you had that amount of money, ask yourself if it went down by 20% in a matter of a month or two, how would you feel about it.  Obviously not good, no one ever feels good about it.  Would you be worried if it kept going down? Or would you be ok knowing you were in this for the long term, and you will be okay as long as you ride it out.  If you don’t think you can handle the 20% downward move, then you need to ask if you would be comfortable with a 10-15% move down.  If you don’t feel comfortable there, then you probably don’t need much if any risk in your portfolio.  You should always use your risk tolerance as your baseline for your financial goals.

The next factor we’ll look at is your time horizon.  Time horizon is extremely important because it also helps you decide how aggressive you can be with your investments if you have a specific purpose for those funds.  If you’re looking at your retirement portfolio, you may have 20, 30, or 40 years until you need those funds.  Historically, the  S&P 500 has averaged at last 7% in any 20 year rolling period.  When you have longer term time horizons, you can stand to be invested to your max risk tolerance.  If you’re an “In It To Win It” type of risk tolerance, and you have 20 or more years before you need the funds, then you can be 100% aggressive stocks.  The shorter your time horizon, the more conservative you must be because you do not want to worry about a market correction when you need those funds. If you’re an “In It To Win It” risk tolerance, but you need the funds in the next 5 years, you may want to scale your investments back to a 60/40 split between stocks and bonds, then as you get within a year of 2 of needing the money you may want to put it in a money market or certificate of deposit.  If you have Limited risk tolerance, then you are likely only going to be in fixed interest rate type of products like money market funds, certificates of deposits, and bonds. You may possibly have some stock exposure if you have a long-time horizon.  Remember, your baseline should always be your risk tolerance, then you can scale your investment selection back based on your time horizon targets.

Let’s talk about your financial goals now that we understand risk tolerance and time horizon.  If you haven’t done so already, you should probably have some numbers in mind of short-term goals and long-term goals for your finances.  Some short-term goals may be to buy a house or car, some long-term goals may be to retire at 55 years old.  Your goals are going to be different than everyone else’s.  It’s important that you have an idea of how much you need and when you need it for your financial goals.  You may need $2,000,000 to retire by the age of 55 which is what it would roughly take to live on an $80,000 a year salary in today’s dollars.  If you are 30-year-old and you have $100,000 saved already, you would need to save roughly $1,900 a month averaging 7% a year in order to reach your retirement goal by the age of 55. Remember, 7% is a very average return for the market for any 20-year rolling period.  If you can afford the $1900 per month and invest your money in an average index strategy or growth allocation, then you should be on target to meet your goals.  Maybe you don’t have $1,900 a month, but you can save $750 a month.  Now, in order to come close to your target of $2,000,000, that $750 a month needs to average about 10% per year to reach your target.  You’ve got a long time until you need those funds, you have already determined that your risk tolerance is very high, so you might want to decide to be in a more aggressive growth fund that has some international and emerging market exposure.   Let’s look at another scenario. You are thinking about making a big purchase in the next 3-5 years.  This may be a car, or you need a downpayment on a house.  After you’ve gone through the risk tolerance question, you have determined that you are very risk tolerant, but your time horizon is shorter than you really need to be riskier with these funds.  Since your time horizon is shorter, you need to reduce your risk in order to protect the funds you have saved for this shorter-term purchase.  If you have 5years, you can possibly stand to be 60/40 between stocks and bonds for 2-3 years, then you may need to switch to Money market funds and certificates of deposits or treasuries for the last 2-3 years as you get closer to needing the funds.  Yes, you could make more money if you were riskier, but what if you are ready to make that purchase and your portfolio is down 10-20% at the same time.  You don’t  want to cash your investments in at the lower price.   That’s why you need to keep these funds in a more secure investment, even though they may not make as much, you will have access to them when you need them.

Some general guidelines I would suggest would be if you need your funds in the next 1-3 years, no matter your risk tolerance, those funds should be kept in safer vehicles like money market funds and certificates of deposit or short-term treasuries.  If you don’t need your funds for at least 5 years, then you can stand to be the step down from your long-term risk tolerance.  For instance, if you were in the high-risk tolerance level, you could choose a 60/40 split for your 5 year goals.  If you were in the middle risk tolerance, you could maybe choose to be primarily bonds with a little stock exposure, maybe 40/60 split between stocks and fixed income.  If you have a 10 year or longer time horizon, you can utilize your max risk to tolerance for those financial goals.

Now that we’ve discussed all the major factors to consider when determining your portfolio mix, here’s a quick guideline to go by.


Risk Tolerance               10+ years                      5-10 years                     Under 5 years

Limited tolerance          0-40% stocks/                 Mid term bonds            CD’s, Money Market

60-100% Bonds             CD’s, Money Market


Some Tolerance            60-80% Stocks/             20-40% Stocks/             Bonds, CD’s, Money Market

20-40% Bonds               60-80% Bonds


In It to Win IT                100% stocks                  60-80% Stocks/             20-40% Stocks/

20-40% Bonds               60-80% Bonds

CD’s, Money Market


Keep in mind this is not a one size fits all approach.  This should be used as a guideline to help you determine a good mix for your portfolio based on your risk tolerance, time horizon, and financial goals.  Notice in several of the risk tolerances and time horizons, there are some different ranges.  Remember, if you are not comfortable making these decisions yourself, you should reach out to a local financial advisor to help you make a more informed decision.

“Investing involves risk. These are the opinions of [rep/author name] and not necessarily those of Cambridge, are for informational purposes only, and should not be construed or acted upon as individualized investment advice. Depending on the different types of investments there may be varying degrees of risk. Socially responsible investing does not guarantee any amount of success. Clients and prospective clients should be prepared to bear investment loss including loss of original principal. Indices mentioned are unmanaged and cannot be invested into directly. Past performance is not a guarantee of future results.”