The Three Dimensions of Risk — And How We Engineer Around Them

Most advisors collapse risk into a single number.

We don’t.

At Shell Capital, we treat risk as three distinct dimensions that must align before capital is deployed: Risk Tolerance, Risk Required, and Risk Capacity.

If those three aren’t reconciled, the portfolio is structurally unstable — no matter how sophisticated it appears.

Let’s break down how we use this.

Risk Tolerance: The Psychological Constraint

Risk tolerance is emotional comfort with uncertainty. It’s relatively stable over time. Some people are comfortable with volatility. Others aren’t — even if they intellectually understand markets.

This matters because no portfolio survives if the owner abandons it at the wrong time.

We treat risk tolerance as a boundary condition. It defines the outer limit of acceptable volatility. We don’t override it. We design within it.

But we also don’t let it dictate the math.

Risk Required: The Return Constraint

Risk required is the level of return necessary to achieve the objective.

This is arithmetic, not opinion.

If a family’s plan requires 8–10% annualized returns to sustain distributions and future transfers, then a low-volatility 3% portfolio isn’t conservative — it’s structurally incompatible.

High required return means thinner margins for error. That doesn’t mean we chase beta. It means we structure asymmetry — defined downside, convex upside, disciplined exits.

When required return is misaligned with tolerance or capacity, the plan is fragile before markets even move.

Risk Capacity: The Absorption Constraint

Risk capacity is the financial ability to absorb loss without permanently impairing lifestyle or long-term objectives.

If markets trend against us, does the plan bend — or break?

A family with excess capital relative to spending needs has high capacity. A family whose success depends on cooperative markets has low capacity.

And here’s the paradox: those who need lower returns often have higher capacity to take risk. Those who need higher returns often have the least room for error.

That asymmetry is critical.

Here's how I think of it. 

Imagine driving a high-performance car at The Tail of the Dragon or on a closed track like FlatRock, Road Atlanta, or Sebring. 

Risk tolerance is whether you enjoy speed and tight corners in the first place. Some people love it. My wife don’t want to be anywhere near it.

Risk required is how fast you must go to achieve your objective. On a racetrack, that might be lap time. On a public mountain road, there is no required speed. You can drive 35 mph and still reach the destination.

Risk capacity is the margin for error. On a closed track with runoff areas, safety crews, and controlled conditions, your capacity to absorb mistakes is higher. On a narrow mountain road with guardrails and drop-offs, your capacity is lower. One mistake has greater consequences.

Here’s the key.

If you don’t enjoy speed (low tolerance), you shouldn’t be trying to set track records.

If you must hit a certain lap time (high required return), but you’re driving on a narrow mountain road with no runoff (low capacity), the environment and objective are incompatible.

And if you’re just out for a scenic drive with no time pressure (low required return, high capacity), there’s no reason to push the car to its limits.

In portfolio construction, most advisors hand everyone the same car and tell them to “drive responsibly.”

We engineer the environment first.

We start with required return. We test capacity under adverse regimes. We constrain by tolerance. Then we design exposure with defined exits, position sizing, and portfolio risk controls.

Risk isn’t about thrill-seeking. It’s about control.

When tolerance, required return, and capacity are aligned, the portfolio behaves like a well-driven performance car on the right track — speed where appropriate, braking where necessary, and margin built into every apex.

That’s how capital survives long enough to compound.

Not by guessing.

But by engineering asymmetry.

Mike Shell is the founder and chief investment officer of Shell Capital Management, LLC, a registered investment adviser. He serves as portfolio manager of ASYMMETRY^® Managed Portfolios, a separately managed account program with trade execution and custody provided by Goldman Sachs Custody Solutions.

ASYMMETRY^® Observations are provided for general informational and educational purposes only. They do not constitute investment advice, a recommendation, or an offer to buy or sell any security or investment strategy. The content is not intended to be a complete description of Shell Capital’s investment process and should not be relied upon as the sole basis for any investment decision.

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