In the late 90s, I knew a couple of people that made the decision to try their hand at day trading. The swings of the market were such that a momentum strategy was making a lot of people money. You know what happened: the overall market had a mini crash, purging thousands of dot com companies with no discernable earnings, and taking most equity investors with it. If you were invested in equities, you probably learned something about your risk tolerance when this happened. If you didn’t then, perhaps you’re learning now. I know a couple of people currently experimenting with day trading now as well. Based on the limited amount of research I’ve seen, trying to game market trends is an approach that can beat the overall market in times of market volatility. I have personally never subscribed to the strategy. The premise behind momentum trading has little to do with the underlying fundamentals of a company and lots to do with crowd psychology. That’s why to me (and lots of other people), value investing is the approach that speaks to me with the most clarity.
Regardless of your approach, an underdiscussed topic tends to be risk tolerance. Knowing and understanding your own risk tolerance is a complex thing. The people that I knew that rushed into day trading during a period of volatile (but upward) movement, learned something about their risk tolerance when they started losing their money. It’s easy to believe that you have an unmatched appetite for risk when you’re making money. Of course, making money says nothing about your true appetite for risk. Only losing money does that.
Recent market conditions have forced many people to re-evaluate their tolerance for risk. People have rushed out of equities, forcing redemptions in hedge and mutual funds (which helped pull the market down even further). But what does risk tolerance really mean? I’ve heard people say more than once that you shouldn’t be in equities unless you can stomach seeing your portfolio down by 50% (many investors are there already). Most planners say that you shouldn’t have money in the market that you’ll need in the next five years (sound advice). But again, what does it mean? One thing it absolutely doesn’t mean is that you’re tolerant of losing money. Every investor should be loss averse. Loss is a negative outcome. If you’re saving and investing money only to lose it, you might as well put it under your mattress and let it slowly erode under the grip of inflation or, just spend it already. Risk aversion, to me, is simply a measure of how a particular person reacts to the volatility of an investment.
Defining it is the easy part. Understanding where you fit into the spectrum is another thing altogether. There isn’t a magic way of finding out. Sure, you can take one of the many risk tolerance tests online, such as this one. Of course, it’s still you answering the questions about what you’ll do. And these tests aren’t new. They’ve been around for years. The existence of tests didn’t stop people from liquidating investment accounts right and left.
I guess my advice to you is this, find an investment policy that you feel meets your risk tolerance and stick to it. If you can stand seeing your money seesaw up and down, I would advise you to put a larger amount of money into fixed income investments. That being said, I think almost all investors can benefit from some stock exposure. I think most people either over or under expose themselves to equities. They either love them or hate them. As long as that’s in line with your actual risk tolerance, I think that’s fine.
In the new (post recession) world, many people will scavenge for opportunities amidst the uncertainty and perhaps make money. Many others, having been burned, will stand on the sidelines, wary of equities for as long as their memories serve them correctly. I think the action you take during these times, assuming you can afford to do anything, tells you a lot about your tolerance for risk. Keep the current market conditions, complete with all the volatility and uncertainty, in your mind the next time you evaluate your investment plan – and then stick with it. That should be a fairly honest way to evaluate yourself. Thanks for reading.
For more on risk tolerance, check out this post.
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I live in die by value investing. Never had understand the “chart chasers” as I call them. All of my single holdings are values, and the only growth investing I’ve ever done is in international mutual funds.
I’m failry tolerant to risk, but I’m not tolerant to investing in things that don’t have an asset backing the value.
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