Do your investments express your risk tolerance or better stated your comfort with risk? Most often risk tolerance has been approached intellectually.
You may have been told:
- You are young and should take risk.
- You are retired you should be risk averse.
Some even add gender bias into the conversation:
- Man up and have an aggressive portfolio. Real men take risks.
- Women are more conservative by nature.
Your employer may default you into a choice:
Target date investment strategies are a popular option for 401(k) plan. Unfortunately, someone that knows nothing about risk tolerance, has decided what they think yours should be. Maybe even more alarming is that there are varying thoughts from one manager to another on what the risk level should be at a given point in time.
Others ask questions like:
- What is your comfort in investing in value companies?
- What do you think about stocks vs. bonds?
Risk tolerance and emotions
Comfort with risk is most often an emotional one. Let’s say that you have a million dollars and that is the only money you have. Would you be comfortable losing $250,000 for the possibility of seeing it grow by $350,000? Daniel Kahnemann, Nobel Prize Winner for his work in behavioral economics found that people are twice as emotional about the loss as they are about the gain. That means you likely would experience that loss as $500,000. Is that you?
Investing, goals and risk tolerance
I believe in investing based on your goals. That means that you are saving to reach a goal such as funding your retirement or your children’s college education. That requires manipulating the variables of savings, investment return and time. If you are investing for retirement in a 401(k), you are using a systematic investing strategy aka dollar cost averaging. When the market is down, you get more shares of stocks or bonds for the same investment. When the market returns back, this accelerates the growth of your account. Such a plan does not assure a profit and does not protect against loss in declining markets.
However, many investors can’t stomach the ups and downs and try to jump in and out of the market at the right time.
Some investors that call themselves aggressive engage in this behavior. That does not appear aggressive to me. It is just another way of dealing with feelings of uncertainty about loss. It is a grasp for control that no one has yet to consistently get right. If you can’t time the market perfectly, you are likely better off to find the balance of investments, historically that matches to your risk tolerance. The Dow Jones indices has a great tool to see this in action.
Risk tolerance and your comfort zone
If you are like many I talk to, your risk tolerance when the market is good is different than when it is bad. When considering your risk tolerance, you might question the level of loss you can stomach without changing. If you are like many people, you shifted your investments into cash when the market dropped in 2008 and 2009. If that was you, you were not in your risk comfort zone.
Finding your Comfort Zone
Over a six month period how would you feel if you saw your balance, say $100,000:
- Go down $5000 to gain $10,000?
- Go down $25,000 to gain $50,000?
- Go down $50,000 to gain $100,000?
It is important to know what level of loss causes you to cash out. I’ve provided access to a tool called Riskalyze to help you figure out your comfort zone.
You are welcome to take the self-assessment below to find out. You are under no obligation to work with us. You can use it to have a conversation with your current broker who may not have access to this tool. If you qualify to work with us and want us to help, we would be glad to help you align your existing portfolios with your comfort zone.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. The target date is the approximate date when investors plan to start withdrawing their money. No strategy assures a profit or protects against a loss.