Why Investors Can’t Measure Their Own Risk Tolerance

When people start investing money, one of the exercises they engage in is determining their own risk tolerance.  Usually, this process is handled by filling out some sort of questionnaire that has multiple choice questions like the one below. ‘If you had $10,000 to invest, would you….’ Be willing to chance earning 30% growth knowing you could lose 30% Be willing to chance earning 10% growth knowing you could lose only 5% Be willing to lose nothing knowing you could earn no more than 5% We often whisk through these quizzes at a blazing pace because in a simulation exercise we know exactly who we are.  However, there are two types of behaviors that we have within our personality.  How we act in a natural state when we are relaxed and have no pressure.  Then, there is the adaptive state when we are under heavy pressure.  Unfortunately, these quizzes don’t really put us under any pressure so they don’t really ...

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What If You Were Down 27%?

The Dow Jones industrial average (DJIA) rose 72.37 points, or 0.4%, to 16,576.66 on the last trading day of 2013. For the year, the index of blue-chip stocks was up 26.5% — its best performance since 1995.   The media, can sometimes be our friend or our foe.  Unfortunately, because our lives are so busy we often just get snippets and sound bites of information about our investments and money issues.   When you hear the DJIA had a banner year, your first thought is often “did my investments do as well as the stock market?” Most investors have a very short memory of their original risk tolerance, goals, or objectives when they start analyzing returns on their money.   Without setting proper expectation, banner years in the stock market like 2013 can send you into the depths of unhappiness because you may feel you missed out on a golden opportunity.  However, what happens if you were down 27% or even 33.84% as ...

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