Author Topic: Determining Risk Tolerance?  (Read 3915 times)

StressLess

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Determining Risk Tolerance?
« on: July 09, 2015, 09:35:28 AM »
Hey guys,

Has anyone found a good tool/metric to determine risk tolerance?

I understand the principles of developing a solid plan and sticking with it, just having a tough time gauging what my true tolerance is.

Suppose you never know until you hit a bear marker - people tend to over assume their risk tolerance during the good times, right?

But any personal ideas would be appreciated!

many thanks

wienerdog

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Re: Determining Risk Tolerance?
« Reply #1 on: July 09, 2015, 10:05:07 AM »

StressLess

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Re: Determining Risk Tolerance?
« Reply #2 on: July 09, 2015, 10:14:51 AM »
Thanks for that.

Yeah it usually suggests around 80/20 equities/bonds respectively. 

I guess my main concern is being a new investor and overestimating risk tolerance.  I got scared early on by a family member telling me to go all cash in 2012, which i did...feeling very foolish slowly started understanding principles and developed a policy which i have been following.  some of the losses from early in the week scare me a bit but i guess i should just logon to the accounts less often?

scojo

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Re: Determining Risk Tolerance?
« Reply #3 on: July 09, 2015, 10:21:18 AM »
Following, because I would love to hear people's answers.

I think my issue may be I have a poor understanding of Risk.  When I think of risk, I think of volatility.

And then I look at this:

 

and can't think of a reason to not go 100% stocks in the accumulation phase.

So I would love to hear how other people are quantifying their risk tolerance, and using that quantity to determine an asset allocation.


Kaspian

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Re: Determining Risk Tolerance?
« Reply #4 on: July 09, 2015, 10:26:35 AM »
Thanks for that.

Yeah it usually suggests around 80/20 equities/bonds respectively. 

I guess my main concern is being a new investor and overestimating risk tolerance.  I got scared early on by a family member telling me to go all cash in 2012, which i did...feeling very foolish slowly started understanding principles and developed a policy which i have been following.  some of the losses from early in the week scare me a bit but i guess i should just logon to the accounts less often?

That's a very, very smart observation and as a new investor, I'd say you're leagues above others!  Like I said somewhere else, it's easy to be brave of sharks while the boat is safely afloat.  So, in the case it's far better to underestimate your risk tolerance than overestimate.  No matter what anyone tells you, there's nothing wrong with a 70/30 or even 60/40 split.  Having a slightly bigger safety net than you need is prudent.  The biggest enemy in personal investing is yourself.  If you do have a policy, you should probably stick with it--don't reorganize because of fear because that is the real danger.  (Tinkering.)  If you don't have a formal plan, adjust your safe investments up with new contributions?  (They've likely become unbalanced this year anyway.)

Kaspian

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Re: Determining Risk Tolerance?
« Reply #5 on: July 09, 2015, 10:33:45 AM »

and can't think of a reason to not go 100% stocks in the accumulation phase.


#1 Reason:  Emotion.  You're human.  If you're new and in the accumulation phase and your portfolio suddenly drops -25%.  Then another -2% the next year.  Then another -1%.  Meanwhile you see the price of bonds have gone through the roof--people invested there have done exceedingly well.  It's easy to say you'll stick with a plan for the "long-term" but a year is a very, very long time when you see your portfolio do nothing but suffer.  So, you decide to switch out when your equities are at the bottom to get in on the bond action.  "Bond action? There is no bond action!"  Yes, there was--some pretty huge gains too.  This is the problem almost every small investor faces--emotion, performance chasing, recency bias.


Aphalite

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Re: Determining Risk Tolerance?
« Reply #6 on: July 09, 2015, 10:34:11 AM »
I think my issue may be I have a poor understanding of Risk.  When I think of risk, I think of volatility.

When I think of risk, I think of the probability of permanent capital loss. I think volatility is a useless measure of long term risk because I don't care if stock prices decrease, as long as the underlying earnings of companies are okay and increasing. Risk to me means companies that have focused production facilities, where one natural disaster can wipe it out, or carrying too much debt, as one credit crunch can result in the company ceasing to operate, or paying too much for a dollar of earnings, which results in capital loss down the road if the company does not grow its earnings in line with investor expectations. These are the things that have me worried about my investments, not if the stock price goes up or down

To OP - it's more of a mental exercise than anything else - do you see yourself clicking the sell button if you see red on your accounts? How do you feel when you gamble in a casino? Do you have extreme highs and uncomfortable lows? The larger the gap between the two state of minds, the lower your risk tolerance is. Investing requires a very specific temperament, and the less tolerance you have for price fluctuation, the more you should tilt towards fixed income investments (or REI, since no one will be quoting you a price every day)

forummm

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Re: Determining Risk Tolerance?
« Reply #7 on: July 09, 2015, 10:39:47 AM »
Following, because I would love to hear people's answers.

I think my issue may be I have a poor understanding of Risk.  When I think of risk, I think of volatility.

And then I look at this:

 

and can't think of a reason to not go 100% stocks in the accumulation phase.

So I would love to hear how other people are quantifying their risk tolerance, and using that quantity to determine an asset allocation.



Sometimes it looks like this:


If it's your life savings, and the news is full of bank failures, high unemployment, everything is terrible--do you panic and sell?

DrF

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Re: Determining Risk Tolerance?
« Reply #8 on: July 09, 2015, 10:43:12 AM »
Whenever I see my investments go down, I think to myself.... man it's a good time to buy.

StressLess

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Re: Determining Risk Tolerance?
« Reply #9 on: July 09, 2015, 10:43:49 AM »
Thanks Kaspian.  I appreciate the feedback. Yeah i have a solid AA and my plan is to stick through it thick and thin.

@ aphalite: I don't really gamble at casinos - but when i have done so ~10 years ago, it didnt phase me very much when i lost 300.  but i was 20 and nothing really bothered me back then!!  You are right about investing requiring a certain mindset or temperament.  seeing the big picture rather than the day to day should help me develop that.

thanks

StressLess

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Re: Determining Risk Tolerance?
« Reply #10 on: July 09, 2015, 10:47:52 AM »
Following, because I would love to hear people's answers.

I think my issue may be I have a poor understanding of Risk.  When I think of risk, I think of volatility.

And then I look at this:

 

and can't think of a reason to not go 100% stocks in the accumulation phase.

So I would love to hear how other people are quantifying their risk tolerance, and using that quantity to determine an asset allocation.

that period between the mid sixties and the early eighties is pretty intimidating!

NoraLenderbee

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Re: Determining Risk Tolerance?
« Reply #11 on: July 09, 2015, 03:02:33 PM »
You can't really know until it happens. It's harder than you think to sit tight in a bear market. It's even harder to invest in one. But it's not impossible. :)
Not sure I understand the casino test. I don't gamble because I hate, HATE losing money. Does that make me super risk-averse? In 2008, I didn't sell, because that would have meant realizing losses, i.e., just the thing I hate. Does that make me risk-tolerant? I even invested a little extra (didn't have the stomach to go all in).

Eric

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Re: Determining Risk Tolerance?
« Reply #12 on: July 09, 2015, 04:41:13 PM »

lostamonkey

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Re: Determining Risk Tolerance?
« Reply #13 on: July 09, 2015, 05:42:32 PM »
Another decent casino comparison is would you bet 5% of your NW on red if it paid 3:1. I absolutely would without a second thought and losing wouldn't really bother me.