Risk tolerance is how you feel. Risk capacity is what you can afford — and only one of them pays the bills. This works out the largest fall your plan can absorb while still funding the essentials, then checks it against what you're actually exposed to.
There's a difference between the risk you can handle emotionally and the risk you can afford financially. This measures the second one.
Risk tolerance is temperament — how you feel when the numbers go red. Most questionnaires measure this, and it's worth knowing, but it doesn't pay any bills.
Risk capacity is arithmetic: how large a fall can your plan absorb and still fund the things you can't switch off? A calm person with thin margins has high tolerance and low capacity, which is a genuinely dangerous combination — they'll hold through a crash that their plan can't survive.
Carol has $900,000, spends $70,000 a year, and has $28,000 of pension income. Of her spending, $50,000 is essential — housing, food, insurance, medical — and $20,000 is discretionary.
Her portfolio has to find $22,000 a year of essential spending for 28 years. Working backwards, that needs about $425,000 of capital. She has $900,000, so she could lose roughly 53% and still cover the essentials.
With 55% in shares, a repeat of 2008 would cost her about 31% of the portfolio.
She has around 22 percentage points of headroom, so the risk she's taking is affordable. Her weaker point is elsewhere: her cash and short bonds cover about 2.1 years of portfolio-funded spending, and the dot-com bear market took 31 months just to reach its bottom. She has the capacity to hold through a crash, but not quite the liquidity to be certain of avoiding a sale during one.
Look at the concentration line. Index funds crash and recover — that's what the historical scenarios show. Individual companies sometimes simply don't, and none of the scenarios on this page capture that. If a large slice of your money sits in one holding — often a former employer's shares, held out of loyalty or inertia — that's the risk most likely to be genuinely unrecoverable, and it doesn't appear in any volatility number.
The good news is that it's also the easiest one to fix, and unlike most things in investing, fixing it doesn't require predicting anything.
General information only — not financial advice. "Maximum tolerable drawdown" is calculated as the fall that still leaves enough capital to fund your essential spending for the full horizon at the conservative real return you entered; it assumes no further losses and no change in your income. Historical crash figures are peak-to-trough S&P 500 declines, used because they are the best-documented; most developed markets fell by broadly similar amounts in these episodes. They are, applied to your equity allocation with bonds and cash held flat. A concentrated single holding can fall far further than any index and is not modelled by these scenarios.