Your perceived investment risk tolerance profile

Almost everyone likes to think they can handle financial risk. It’s sort of like the statistics about people that think they are good drivers versus the polls of how many other people you think are good drivers. I find that us guys are even more susceptible to this risk illusion. It’s understandable considering the concept of taking risks is part of the traditional masculine ideal. “Real men” like John Wayne and Chuck Norris are all about taking risks (of course when you always win it’s not really all that risky). The facts are of course that the vast majority of us don’t mind risk as long as the risk is paying off, but when we start to see that nest egg disappears by leaps and bounds when the marketing is plunging – that is another matter entirely.

I invest all the time – my risk tolerance is great

In case you’ve never taken an investment risk tolerance quiz, the basic idea is that based upon your age, past experience in the financial markets, and your answers to several hypothetical questions, the quiz is supposed to let you know what sort of asset allocation and types of investments would be appropriate for you. Investment advisers are supposed to give one of these risk tolerance documents to you before putting you into any investments.

From what I’ve heard from several financial advisers, the people that are ready to admit that they don’t know anything about investing and have no preconceived notions actually “do well” in terms of getting a result that is an accurate portrayal of their risk tolerance. On the other hand, people (again, mostly men) who’ve done just enough reading to know a few buzzwords and the fundamentals of one or two investing strategies have a much higher ration of misrepresenting their own risk tolerance.

Stupid caveman instincts

The reason for this is that our instincts are not suited for the stock market. The bestseller Thinking Fast and Slow by Daniel Kahneman does a great job of explaining this. Amateur investors might be aware of the risk-reward continuum and logically believe that they will have no problem waiting out the bear markets as they make money over the long-haul – BUT statistics tell us that the vast majority of us will bow out to our baser instincts in the end. It is very interesting to me just how many of us are not willing to admit that seeing our lives’ savings suddenly disappear over a few months after a lifetime of accumulation will cause us an immense amount of stress and anxiety. This seems pretty natural when you think about it. If you’re not one to take cold comfort in long-term averages and trust in the basic system of capitalism – then you probably shouldn’t be in the market at all. In my opinion talking people off of “investment ledges” where they want to sell their entire portfolio at market lows is by far the greatest added value of using an investment adviser.

Couch potato to the rescue!

This is of course one of the reasons why I’m a huge advocate of index investing. I believe that the idea of passively investing is very soothing when compared to the anxiety felt by most active investors. Even if you could sell off your ETFs relatively easily at any point, index investing encourages a mindset of long-term planning and admitting basic market realities to yourself. Of course you’ll never find index investing under “macho” or “tough guy” in the dictionary, and no one will make a movie about you. My advice to people is to go sky diving and/or start kickboxing. Exercise your risk-driven instincts somewhere other than your investment portfolio unless you’re truly able to lose 40-50% of your investments and still sleep sound at night!