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Retirement Income Planning: What's Your Risk Capacity?

Key Points
  • When planning for your retirement income, you need to figure out how much risk you can afford to take in your retirement portfolio.

  • Investors are taught to think of risk as “risk tolerance,” or their comfort level when taking on investment risk. But we think it's more important to know your risk capacity, or how much risk can you afford.

  • Once you figure out your risk capacity, you'll be better able to allocate your investments to meet your needs over time.

When you're planning for your retirement income, you need to know more than just when you'd like to retire and how much money you'd like to have. You also need to factor in investment risk. 

Typically, investors are taught to think of risk as “risk tolerance” or their level of comfort with  investment risk. That is, can you emotionally stomach the ups and downs of your investment portfolio? But there’s another way to think about risk.

What is risk capacity?

Risk capacity is how much risk you can afford. 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 recover?

Over time, investments in stocks and other higher-risk instruments typically generate higher returns thanlower-risk instruments, such as cash and bonds. 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 important it becomes to consider your risk capacity. 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. This is one of those critical concepts in investing.

How does risk capacity apply to your portfolio?

An often-used rule of thumb 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 number in stocks. Then, invest the rest in cash or bonds. But we believe that approach is too simple.

Instead, consider your needs over a short time horizon. If you're nearing retirement, think about how much money you need in 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.

Here's an example.

Fred and Nancy, ages 65 and 63, preparing for retirement
For simplicity, let's assume that Fred 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.

Fred 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 in the first few years of retirement.

We suggest a roughly two-to-four year foundation of more stable investments—short-term bonds and cash investments—before taking more investment risk. For Fred and Nancy, a three-year projection of this need is $50,000 times three years, or $150,000 in cash investments and short-term bonds, using either a short-term bond fund or high-quality bonds or CDs with maturities from two to four years. That leaves $850,000 for other investments. 

A sample portfolio to address Fred and Nancy’s needs


Amount ($)

Amount (%)

Sample funds, for illustration only

Cash investments



Cash allocation

Short-term bonds



MWLDX – Metropolitan West Low Duration Bond

Intermediate-term bonds



BCOSX – Baird Core Plus Bond Fund
MWTRX – Metropolitan West Total Return Bond

High-yield/multi-sector bonds



LSBRX – Loomis Sayles Bond

U.S. stocks



LGILX – Laudus U.S. Large Cap Growth
SWANX – Schwab Core Equity
SWDSX – Schwab Dividend Equity
SWCSX – Schwab Small-Cap Equity

International stocks



FMIJX – FMI International Equity
LISOX – Lazard International Equity




All retirement assets

Source: Schwab Center for Financial Research. All sample funds are selected from the Schwab Mutual Fund Select List, managed by Charles Schwab Investment Advisory (CSIA), and the sample portfolio is created using a moderate (60% stocks/40% fixed income and cash investments) plan allocation and the Schwab Mutual Fund Portfolio Builder tool on Please refer to the Select List or Mutual Fund Portfolio Builder for current sample funds. 

This portfolio contains roughly 60% in higher-risk investments—including a small allocation to high-yield bonds—and 40% in cash and short- and intermediate-term bonds. This is a sound place to start with their portfolio, built on Fred and Nancy's short-term needs but also based on their long-term objectives to grow their portfolio to fund the later years of their retirement.

Although we use mutual funds in this example, you could easily use a portfolio of CDs or short-term bonds with maturities between two and four years to cover your short-term allocation. Some investors may also want to cover their cash-flow needs for four years and beyond using a portfolio of bonds with longer maturities.

As retirement progresses, Fred and Nancy may find their needs increase, and if they plan to spend what they saved, their time horizon shortens. When that starts to happen, it generally makes sense to decrease the allocation to stocks and increase it to cash investments and bonds. This allocation also happens to be about what we would suggest for the average investor at or near retirement. For additional suggestions, refer to these guidelines on

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

We think having a financial cushion designed to last up to four years makes sense for most investors getting close to or living in retirement. 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.

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 periods show 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 would 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.

What to do now

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? Invest the rest based on other factors—such as your risk tolerance, need for cash flow from your portfolio after four years, and other objectives.

For help, use Schwab's budgeting tools on to determine your needs, or talk with a Schwab consultant.

Talk to Us

To discuss how this article might affect your investment decisions:

  • Call Schwab anytime at 877-338-0192.
  • Talk to a Schwab Financial Consultant at your local branch.
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Important Disclosures

For funds, investors should carefully consider information contained in the prospectus, including investment objectives, risks, charges and expenses. You can request a prospectus by visiting or calling Schwab at 800-435-4000. Please read the prospectus carefully before investing.


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