Risk Capacity
By Zeke Anders on January 26, 2024
Charlie Munger, in one of his final interviews, said that Berkshire Hathaway’s record could have been more impressive had he and Warren Buffett used more leverage. He noted that he and Warren could have lost 70% of their net worth and still been very wealthy, but they knew that their shareholders were not in the same position[1]. This is the concept of “risk capacity”. When you have more assets than you “need”, your risk capacity is higher. This is not to be confused with risk tolerance, which is how much risk you feel comfortable taking.
To put some numbers behind this, Warren Buffett’s estimated net worth as of January 11th, 2024 is $121.6 billion. He lives in the same house he has lived in for decades, in Omaha, Nebraska, and by all accounts has a frugal lifestyle. If his net worth were to drop 70%, it would still be $36.38 billion. Buffett could still fund his lifestyle and leave a large legacy to charity and his children and grandchildren. That’s not to say it wouldn’t be psychologically painful, even so. For someone with $1 million, on the other hand, a 70% drop is much more impactful to their lifestyle, or even someone with $10 million or more. Your risk capacity depends not only on the assets you have, but also on the needs of your lifestyle. We talked about this more in a previous piece (Read: https://twickenhamadvisors.com/blogs/unobstructed-thoughts/the-most-important-number-for-your-retirement-isnt-your-account-balance). The lower your lifestyle needs are relative to the assets you have, the higher your risk capacity may be.
What this means to you will depend on your goals and risk tolerance. Even if you have the capacity to take more risk, you may choose not to because additional volatility is uncomfortable for you psychologically. If you have a strong legacy goal to leave generational wealth or to give large amounts to charity, then you might take advantage of your risk capacity to take more risk. This is why there are few one-size-fits-all answers in personal finance. Each decision is an interplay of factors such as longevity, lifestyle, assets, legacy, and risk tolerance. Your risk capacity is an integral part of your financial plan, and can help shape the strategies for pursuing your goals.
[1] https://buffett.cnbc.com/video/2023/12/05/charlie-mungers-final-cnbc-interview.html
Zeke Anders – Planning Specialist | zanders@twickenhamadvisors.com
Disclaimer
Securities are offered through Hightower Securities, LLC member FINRA and SIPC. Hightower Advisors, LLC or any of its affiliates do not provide tax or legal advice. This material is not intended or written to provide and should not be relied upon or used as a substitute for tax or legal advice. Information contained herein does not consider an individual’s or entity’s specific circumstances or applicable governing law, which may vary from jurisdiction to jurisdiction and be subject to change. Clients are urged to consult their tax or legal advisor for related questions.
