What Is Your Real Risk Tolerance

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In the past week stock markets across the world experienced one of the wildest rides since 2011 when the US government played chicken with the debt ceiling. Since 2008 investors have been caught in one of the longest bull markets that gains have become an expected norm. It’s no wonder that when the S&P 500 fell by 10% and almost 1000 points in two days that it came as a big shock and brought fear into the minds of the average investor. It also didn’t help when the media jumped in and declared it a stock market crash with fears of Armageddon to come.

Since then the market has recovered somewhat, but volatility continues in the markets and potential large swings in the market may still come. Now that the first wave has passed us by, the real question to ask oneself is how comfortable did you feel with such wild market swings? Were you super emotional over losing so much money so fast? What’s you true risk tolerance?

Thinking Emotionally

BBmbzviWhen markets fell did you quickly reach for the phone or web browser to quickly liquidate your stock holdings? If you had that sudden urge or you actually sold your equities at the bottom then perhaps your risk tolerance isn’t really as high as you thought it was. Investing in equities isn’t for everyone. Certainly there are much safer investment strategies that can be done to protect your principal, but of course it comes at the cost of lower returns. The more important thing is that whatever investment strategy you take, you must be comfortable with it.

When the markets actually stopped trading after the opening bell 1000 point loss on the S&P, I honestly did not know that it had happened until a colleague of mine told me. Frankly, I don’t watch over my portfolio on a day to day because I don’t day trade nor have a strong emotional attachment to my portfolio. What I do know is that I invest for the long term and I have faith that the economies of our world will continue to grow. That’s my own personal philosophy, but of course it might not be yours.

Choosing The Wrong Strategy

If the markets fell by 10% and your own personal portfolio fell by more than the S&P drop, you might have put yourself into a higher risk situation than you might feel comfortable with. When things do well, we tempt fate with greed and we believe that the good times will continue going, but when the bad comes we are not prepared for it. Fear is greater than greed. We as human beings are more likely to do rash things when we’re in fear.

If your own portfolio fluctuates too much for your liking then perhaps it shouldn’t be weighted so heavily into equities. This is the one biggest mistake average investors make. They tend to pile all of their money into one asset, be it one fund or one stock and hope that it goes up. For safety’s sake, there needs to be balance in your portfolio to really mitigate the volatility that arises when markets turn sour. Simply buying stocks alone is not a good strategy for your mitigating risks on your  investments. Diversifying your money into different asset classes may allow you to sleep more soundly at night.

I’m personally a fan of the Canadian Couch Potato strategy because it incorporates the safety of bonds in an investment portfolio. Bonds don’t grow quickly. They will not make you an instant millionaire. There has never been a success story of a bond buyer turned billionaire, but for an average investor, bonds represent a balancing effect of sorts for an investment portfolio.

bonds_vs_stocks_decline

A quick look back over the last week will show how resilient bonds are to a market correction. They don’t suffer the same kind of drop that stocks do simply because part of the principal is protected. They create a calming effect on an investment portfolio. If you want to limit the impact and volatility of your own investment portfolio, then perhaps bonds are something that you should look into buying in order to smooth out the bumps.

Reflection

Investing is a personal preference that needs to evolve over time to meet the needs of what you want as an investor. Everyone has their own risk tolerance. Perhaps yours is higher than the person beside you. Maybe 50% losses are immaterial to you, but means life and death to someone else. These extremes cannot be enforced on every individual. That’s why as an investor, we need to learn to adapt to ourselves and revisit our investment strategy if it doesn’t jive with our current principles.

Remember that the market doesn’t always go up. There will be good years and there will be bad years. What people fail to realize is that since the 2008 crash the market has had a remarkable bull run. Those that stayed invested and continued investing even after the crash were rewarded with their patience. It might be inevitable that another crash may occur one day, but just remember that if you put faith that the world will continue to grow, the citizens will continue to innovate, then ultimately the markets will reward you again with your perseverance.

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