Composure: The Key To Risk Tolerance

Stephen Kline — Tue, 03 Nov 2009 01:42:13 +0000

I’ve already mentioned in a few posts that it’s vital to have an asset allocation that matches your time horizon and risk tolerance. Figuring out your time horizon is simple enough, but things get a little more difficult when it comes to assessing your risk tolerance. Some advisors will point you to a standard questionnaire that is suppose to measure your ability (or inability) to handle risk. The problem with these quizzes is that they try to measure an individual’s emotional response to varying scenarios with intellectual questions. How you respond to a question about a hypothetical portfolio loss of 50% is probably quite different then how you actually responded last year when the markets were plummeting day after day.

The following article examines how the best gauge of risk tolerance is actually the level of composure one has when something unexpected occurs: Tune In, Chill Out

“People say they’re willing to lose 20%, then they lose 2% and they panic. A more meaningful indicator is composure — your short-term, emotional reactions to unpredictable and uncertain events, such as the market’s ugly sell-off on Friday. How will you handle yourself in the heat of battle? Far too many investors discovered in 2008 and early this year that losing money in quick, sharp cuts was more than they could bear. Those thoughtful risk-tolerance quizzes got shredded when stocks went into free fall. Panicked investors sold what they could, often at any price.”

Some comments on Buffett’s, “Be fearful when others are greedy, and be greedy when others are fearful” quote…

“There’s a good reason why there aren’t more Buffetts among us: Buffett is not only more risk tolerant, he’s more composed. When the shooting starts and money is on the line, Buffett comes across as cool and unemotional. And he fires back. Think Clint Eastwood with a calculator.”

On how you can increase your composure…

“First, commit to an investment policy with a long-term or big-picture focus that recognizes there will be major pitfalls along the way. This is your battle plan. The most effective policy statement lays out objectives. These include return goals — how much money you’d like to make — and the potential obstacles to that happy outcome. In this way, you get a sense of how emotions dictate your actions.”

“Second, divide your wealth into different mental accounts with varying degrees of risk. Investors should not be diversifying asset classes; they should be diversifying risk.”

Has Investor Risk Tolerance Changed Forever?

Stephen Kline — Sun, 22 Feb 2009 20:28:41 +0000

The historic drop in the markets that has taken place over the past year has even the most seasoned investors shaken. Very few investors have ever seen a bear market of this stature during their investing careers, and one has to wonder whether overall risk tolerance has changed for good.

Personally speaking this bear market has reinforced the idea of having a proper asset allocation. I’d say even the most aggressive investors with long time horizons would benefit from having a minimum of 10% of their portfolios in bonds to lessen volatility. For those investors closer to retirement, a portfolio consisting of 40-50% bonds would be more appropriate. A proper asset allocation won’t prevent you from taking losses during severe bear markets, but it will ensure that you live to fight another day.

Here’s an interesting piece from the New York Times that examines how our current crisis is changing the way investors look at risk.

Generation Y Investor » Risk Tolerance

Composure: The Key To Risk Tolerance

Has Investor Risk Tolerance Changed Forever?