Your Tolerance for Investment Risk Is Probably Not What You Think
Questions financial advisers ask clients to get at the answer actually measure something completely different—often leading to misguided investment strategies
they take all sorts of different concepts—such as regret, fear and overconfidence—and they lump them all together under this vague concept called risk. Each of those things is worth understanding and examining on its own.
.. people who are labeled as having a high tolerance for risk may really be reflecting dangerous overconfidence. You don’t want them owning portfolios of risky stocks because they have a mistaken sense of their ability to pick winners. Conversely, investors who are considered to have a low tolerance for risk could actually be excessively afraid of daily ups and downs. Instead of having them forgo the returns from stocks, better to teach them to overcome the fear, rather than let the effects of fear bleed into their investment decisions.
.. Rather, how people feel about a big decline depends almost entirely on what has been happening in the market recently. So asking people how they would feel if the market falls 40% is likely to elicit an answer “I am afraid” in the wake of a big decline, and elicit “I am not afraid” when the market has been moving up. Asking people today how they felt in March 2009 is likely to elicit a response indicating less fear than they actually felt in 2009.