You’ve just discovered that you’re not as brave as you thought. Don’t make it worse by acting on your fear.
December 3, 2008
(Money Magazine) — When new clients come to me, I ask them a few questions about risk. One is “What would you do if the value of your stocks fell by 50%?”
The vast majority answer that they would buy more stocks. So now that the market has lost about 40% of its value, why are some of these same clients clamoring to sell?
Risk tolerance ebbs and flows. From 2003 to 2007, U.S. stock prices nearly doubled and international shares nearly tripled.
During such good years, you tend to believe that you have a high tolerance for risk. At times like these, your willingness to take chances drops sharply.
Such mood swings can lead you to jump in and out of the market and chase good performance, with devastating results.
According to a 2007 study of investor returns from 1991 to 2004 published in the Journal of Banking & Finance, the average investor pays a 1.5-percentage-point annual penalty for that kind of behavior.
My advice is to never rely on a risk questionnaire to tell you how much you should have in the market.
I ask about risk tolerance only to make the point that hypothetically losing half of your portfolio doesn’t inspire the same fear that actually losing it will.
Your investment strategy should instead be based on your goals, your time horizon and what you’ve saved so far. Success will come…
