Is now the best time to accurately assess risk tolerance?

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Is now the best time to accurately assess risk tolerance?

Postby Browser » Wed Mar 13, 2013 12:19 pm

I'm among those who have been unwilling to increase my equity allocation up to the level I think it "should be" based on evaluating my need, willingness, and ability to assume equity risk in my retirement portfolio. It's primarily because I'm nervous about stocks based on the volatility and poor returns since 2000 and the big run-up since 2009 that seems to me to be based more on extreme financial engineering than fundamentals. On the one hand, my reluctance to invest as much as I think I '"should" in stocks might just be a recency effect. But on the other hand, I began to ask: shouldn't one's "true" risk tolerance be based on how you feel when your gut feels that equity risks are high? Maybe my true risk tolerance is actually what I'm willing to invest in stocks now, and I've been kidding myself about what it "should" be? This might actually be the best time to reveal my actual risk tolerance going forward, and I should just recalibrate. What do you think?
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Re: Is now the best time to accurately assess risk tolerance

Postby chaz » Wed Mar 13, 2013 12:22 pm

It seems that you have correctly assessed the issue.
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Re: Is now the best time to accurately assess risk tolerance

Postby richard » Wed Mar 13, 2013 12:26 pm

If you're going to change your asset allocation based on something other than an objective change in your circumstances (e.g., major change in personal finances), then you should wait a while before starting and should make the change slowly, in order to be sure you are not suffering from recency or other psychological issues. If your change would be to buy more of something that's gone up recently or to sell something that's gone down recently, or to do something based on recent headlines, wait even longer and proceed even more slowly.

Possible exceptions for not being able to sleep at night or the like, but if you've made a big change before for this sort of reason, proceed very cautiously.
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Re: Is now the best time to accurately assess risk tolerance

Postby Hub » Wed Mar 13, 2013 12:32 pm

I have a few lumps (2 Roths, ESA max, HSA top off) sitting in cash right now. With April 15th looming it's time to get my 2012 final contributions to work, but I'm having a hard time with going in at this price. I know better and don't have a problem with my ongoing monthly contributions doing their thing, but there's something about knowing that I will know that I lump summed in at 14,500 dow that is bothering me.

I don't know if this relates to risk tolerance or not.
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Re: Is now the best time to accurately assess risk tolerance

Postby Fallible » Wed Mar 13, 2013 12:38 pm

Browser wrote:I'm among those who have been unwilling to increase my equity allocation up to the level I think it "should be" based on evaluating my need, willingness, and ability to assume equity risk in my retirement portfolio. It's primarily because I'm nervous about stocks based on the volatility and poor returns since 2000 and the big run-up since 2009 that seems to me to be based more on extreme financial engineering than fundamentals. On the one hand, my reluctance to invest as much as I think I '"should" in stocks might just be a recency effect. But on the other hand, I began to ask: shouldn't one's "true" risk tolerance be based on how you feel when your gut feels that equity risks are high? Maybe my true risk tolerance is actually what I'm willing to invest in stocks now, and I've been kidding myself about what it "should" be? This might actually be the best time to reveal my actual risk tolerance going forward, and I should just recalibrate. What do you think?


ALWAYS is the best time to accurately assess risk tolerance because your tolerance can change. I also agree with Chaz that you are correctly addressing this issue (by asking questions). IMO, it isn't just that your risk tolerance should be based on how you feel, but that how you feel IS your risk tolerance. If the risk is too high, that feeling can translate into the so-called "sleepless nights" and bailing out of the market at a loss. There are endless articles and books on this in our wiki, of course, but one of my recent favorites is from Rick Ferri: http://www.forbes.com/sites/rickferri/2 ... tolerance/
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Re: Is now the best time to accurately assess risk tolerance

Postby FinancialDave » Wed Mar 13, 2013 12:40 pm

Hub wrote: I know better .....

I don't know if this relates to risk tolerance or not.


I think it relates more to what is sometimes called "investor bias." We know better, but somehow don't do what we should.

I decided long ago, when I always seemed to buy or sell at the wrong time, that I would not try to "out smart" the market -- at least all on one day!

:oops:
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Re: Is now the best time to accurately assess risk tolerance

Postby Twins Fan » Wed Mar 13, 2013 12:42 pm

Browser, it sounds like your "risk tolerance" side and your "think it should be" side are two different things. My suggestion would be to listen to your risk tolerance side and tell that other side to "shut it". :happy You will sleep better that way.
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Re: Is now the best time to accurately assess risk tolerance

Postby Blues » Wed Mar 13, 2013 12:46 pm

Twins Fan wrote:Browser, it sounds like your "risk tolerance" side and your "think it should be" side are two different things. My suggestion would be to listen to your risk tolerance side and tell that other side to "shut it". :happy You will sleep better that way.


I think this is good advice. Woulda, coulda, shoulda is one thing...peace of mind...priceless.

Risk tolerance is a moveable target. Mine is way lower now than it was in the past and I've no regrets as it reflects my current circumstances more accurately imho.
Last edited by Blues on Wed Mar 13, 2013 12:47 pm, edited 1 time in total.
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Re: Is now the best time to accurately assess risk tolerance

Postby YDNAL » Wed Mar 13, 2013 12:47 pm

Browser wrote:I'm among those who have been unwilling to increase my equity allocation up to the level I think it "should be" based on evaluating my need, willingness, and ability to assume equity risk in my retirement portfolio.

What does that [the quote] mean?... for instance going from 50% Equity to 60% (+20%), to 70% (+40%) ?
  1. What do you see in added potential/projected benefit from such action?
  2. My opinion is that MUCH is made (and too often) from this.
  3. Work longer, save more, sleep better.
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Re: Is now the best time to accurately assess risk tolerance

Postby Random Musings » Wed Mar 13, 2013 12:51 pm

In my written investment plan, equity exposure is detemined by need and with some adjustments to willingness (valuations). Due to that, I have never been over need of risk this decade and my returns have been reasonable.

Investors today are faced with a current bond environment with low expected real returns that is less attractive than the equity market (with slightly higher expected real returns). However, volatility in equities is typically higher than bonds during most stretches of time which I think is causing some investors to mull over this situation.

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Re: Is now the best time to accurately assess risk tolerance

Postby wesleymouch » Wed Mar 13, 2013 12:54 pm

You might want to look at risk parity portfolios which have a lower stock allocation but have some hard assets. They have a good track record.
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Re: Is now the best time to accurately assess risk tolerance

Postby The Wizard » Wed Mar 13, 2013 1:00 pm

Right now, by itself, does NOT seem to be the time to get an accurate read on one's tolerance.
Whether you're 50% in stocks or 80% in stocks, it's all been good over the past two years, right?
When the next 20%+ decline in stocks happens, THEN you will have a better understanding on your tolerance, which must weather BOTH ups and downs...
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Re: Is now the best time to accurately assess risk tolerance

Postby BBL » Wed Mar 13, 2013 1:03 pm

Now may be a fine time to assess your risk tolerance but the test of that assessment will come in the teeth of a Bear.
To win without risk is to triumph without glory. Pierre Corneille
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Re: Is now the best time to accurately assess risk tolerance

Postby EDN » Wed Mar 13, 2013 1:09 pm

Browser wrote:I'm among those who have been unwilling to increase my equity allocation up to the level I think it "should be" based on evaluating my need, willingness, and ability to assume equity risk in my retirement portfolio. It's primarily because I'm nervous about stocks based on the volatility and poor returns since 2000 and the big run-up since 2009 that seems to me to be based more on extreme financial engineering than fundamentals. On the one hand, my reluctance to invest as much as I think I '"should" in stocks might just be a recency effect. But on the other hand, I began to ask: shouldn't one's "true" risk tolerance be based on how you feel when your gut feels that equity risks are high? Maybe my true risk tolerance is actually what I'm willing to invest in stocks now, and I've been kidding myself about what it "should" be? This might actually be the best time to reveal my actual risk tolerance going forward, and I should just recalibrate. What do you think?


I don't get it?

NEED is pretty straight forward: what return do you require? Either you own the portfolio with the highest probability of getting that return, or you hold something safer with a lower expected return and you save more or postpone your end date. NEED is the most important determinate.
Need is like "I need to lose 50 pounds or I will die from diseases associated with obesity".

WILLINGNESS is just your tolerance for enduring the downside associated with the allocation you've chosen as estimated by 1929-1932, or better yet 73-74, 00-02, and 08. How does this year or last year or even 2008 change that? 2008 wasn't materially worse than 1973-1974, and that downturn should have been studied and factored in by every investor long before 2008. WILLINGNESS is actually better described as what you will have to endure to have the highest probability of success based on the right allocation you've chosen for you. The goal should be success, not to "avoid losing money".
Willingness is like "the amount of your willpower to go to the gym and start eating healthier".

Now, of course, if you become unhinged during bear markets, and just know you won't be able to stay with your plan when things get rocky, either hire someone to help you refocus on long-term, or choose a safer allocation (you'll still probably panic because fear is driven by the unknown future, not the known past or present, but less losses help a little) and save more, work longer, and spend less. They are all sacrifices with no assurances.

ABILITY is tied to the stability (or lack thereof) in other facets of your life: job, income, the nature of your liabilities, etc. And these don't change much, very unlikely a market rise impacts this much--this is a personal situation.
Ability is like "certain physical problems or food allergies that restrict some prescribed wellness activities".

Knowing what to do isn't that hard. Doing it (and staying with it), that's more challenging.

Too many people's investment plan's are the equivalent of: I know I hate working out so that ain't gonna happen, and I know I love ice cream and candy bars so I'm not gonna cut those out, but if possible I'd like to lose 50 pounds. No way is that gonna work.

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Re: Is now the best time to accurately assess risk tolerance

Postby Browser » Wed Mar 13, 2013 1:24 pm

According to Larry Swedroe, your default tolerance level should be the lowest of need, ability, and willingness. It does no good to hold a large allocation to stocks based on need if I'm unlikely to be able to hold onto that allocation in a severe bear market, so need should not trump other considerations. I agree with that view.
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Re: Is now the best time to accurately assess risk tolerance

Postby bogleblitz » Wed Mar 13, 2013 1:33 pm

Relying on gut feeling is not good. Your gut feeling and risk tolerance changes everyday.
People can take more risk when market has been going up.

I recommend reading "your money and your brain" book to understand that your risk tolerance changes often.
Therefore create a written document on what asset allocation you want and stick with it.
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Re: Is now the best time to accurately assess risk tolerance

Postby NYBoglehead » Wed Mar 13, 2013 1:39 pm

Pick an AA that you are comfortable with and keep it no matter what. One huge reason why investors lag the market is everyone gets all excited and confident when the market is on a tear and buys more stocks, but think the world is coming to an end when the market is going down and sell. Buying high and selling low is a guaranteed way to not make any money.

Pick an AA, and keep that AA no matter what is going on. The only adjustments that should be made are the gradual shifts to a more conservative portfolio as one ages.
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Re: Is now the best time to accurately assess risk tolerance

Postby EDN » Wed Mar 13, 2013 1:46 pm

Browser wrote:According to Larry Swedroe, your default tolerance level should be the lowest of need, ability, and willingness. It does no good to hold a large allocation to stocks based on need if I'm unlikely to be able to hold onto that allocation in a severe bear market, so need should not trump other considerations. I agree with that view.


Instead of resigning to the fact that you are going to try to time the market when uncertainty arises (bailing out after prices have fallen and expected returns have risen), maybe that's what you should work to overcome instead of trying to calculate the bear minimum equity exposure you can get by with and not have your purchasing power risk spike.

Often times, I find that deep seated fear of equities is based on experiences of inadequate diversification (remember, only 1 main equity asset class has no real return since 2000), poor historical investment behavior being blamed on the markets, or the incorrect view that things may go to 0 but if you hold enough bonds you'll do just fine. Not saying any of these are you, just saying they are common.

I'm not Larry and not speaking for him, but just because he has a low risk tolerance and very high fixed income allocation doesn't mean its right for you. Most people's portfolio sizes will achieve their goals if they stay prudently balanced and disciplined, but won't if they try to invest as though they have 10X as much as they do or drag every ounce of volatility out of the mix.

As for bear markets, the one thing I'd say is: maybe find other hobbies than participating on investment chat sites? Not a popular thing to say here, but something to consider. Don't look at your portfolio more than once a year, heck, throw it in a balanced index if you must and don't look at but every couple years. Think you'll miss something? A much bigger and more efficient version of our current markets will be around long after you are, so I seriously doubt it.

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Re: Is now the best time to accurately assess risk tolerance

Postby Blues » Wed Mar 13, 2013 3:25 pm

EDN wrote:I'm not Larry and not speaking for him, but just because he has a low risk tolerance and very high fixed income allocation doesn't mean its right for you. Most people's portfolio sizes will achieve their goals if they stay prudently balanced and disciplined, but won't if they try to invest as though they have 10X as much as they do or drag every ounce of volatility out of the mix.

Eric


In line with the quoted section, Eric, if a person had sufficient income from pension, SS, what have you for their everyday "needs" and lifestyle, how would you position their portfolio? Bonds? Equities? CD's?

Are you of the camp that would take more risk because you can afford to do so...or take less risk because you don't need to do so?
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Re: Is now the best time to accurately assess risk tolerance

Postby grabiner » Wed Mar 13, 2013 11:33 pm

The best time to assess your psychological risk tolerance is in a bear market; it's much easier to say that you will stay the course when your portfolio loses a lot of its value than to actually stay the course. If you had stocks in 2008, what did you do? If you rebalanced, selling bonds in late 2008 or early 2009 to keep your stock allocation, then your stock allocation in 2008 was consistent with your risk tolerance, and you probably have some idea of whether you could even hold more stock. If you sold stock, then your allocation was too high for your risk tolerance, and you shouldn't have as much stock now.

You can assess your financial risk tolerance at any time, and this may change as your situation changes. When you get a new job, or your daughter is born, or you move to a more expensive house, or your son gets a college scholarship, or you receive an inheritance, you need to re-evaluate your ability to take risk.
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Re: Is now the best time to accurately assess risk tolerance

Postby magician » Wed Mar 13, 2013 11:40 pm

Browser wrote:According to Larry Swedroe, your default tolerance level should be the lowest of need, ability, and willingness.

Good advice.

Additionally, if those three levels differ considerably, you need to work to reconcile them: lower one that is too high or raise one that is too low. In your IPS, this reconciliation would fall under the rubric of unique circumstances.
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Re: Is now the best time to accurately assess risk tolerance

Postby Matin » Thu Mar 14, 2013 8:17 am

My trick is to assess my risk tolerance/portfolio/retirement accounts once a year at about the same time of year. For me, I do this in the first quarter of each calendar year. That means in the 20+ years of investing, I've done this exercise about 20 times. Sometimes I move money from one type of fund to another. However, there have been periods of time when I have not moved anything for four or five years. I never, ever try to time the market. I figure out where I want to be and then stay the course.

My recommendation is that you pick a time to assess your current investment portfolio. Make any adjustments that seem right. Let the results ride until the next year.
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Re: Is now the best time to accurately assess risk tolerance

Postby EDN » Thu Mar 14, 2013 1:11 pm

Blues wrote:
EDN wrote:I'm not Larry and not speaking for him, but just because he has a low risk tolerance and very high fixed income allocation doesn't mean its right for you. Most people's portfolio sizes will achieve their goals if they stay prudently balanced and disciplined, but won't if they try to invest as though they have 10X as much as they do or drag every ounce of volatility out of the mix.

Eric


In line with the quoted section, Eric, if a person had sufficient income from pension, SS, what have you for their everyday "needs" and lifestyle, how would you position their portfolio? Bonds? Equities? CD's?

Are you of the camp that would take more risk because you can afford to do so...or take less risk because you don't need to do so?


Hey Blues, thanks for the ? and heads up.

In this case (you also mentioned to me that you have no legacy objectives), your "needed" return hurdle is pretty low. So at least a real return (which rules out 100% bonds) or you are losing money, and probably an extra percent or two just to be safe, if you simply want to avoid volatility and losses to the greatest extent possible while still preparing for the fact that someday, your increased spending needs outstrip your current guaranteed income, or something happens to your income (like your pension implodes), and you will need to rely on this money. I'd set the ceiling at 75% fixed income, and I'd stay clear of anything too adventuresome here (longer-term, lower-quality, etc.). At the same time, I'd hesitate to lock most/any of it up in CDs or annuities with prohibitive surrender penalties despite a marginally higher coupon. Keep it accessible and avoid reaching for yield by assuming illiquidity risks.

But in my experience, just because you have all of your living expenses covered by guaranteed income resources, does not always mean ultra-return/risk portfolios are the best approach. I remember a client I worked with who would never touch their money (not even RMDs), with no living family. But the experience of dealing with a family tragedy some years ago caused them to want to leave their hoped-for significantly appreciated assets to an organization on the cutting edge of researching solutions/cures to this tragedy. We agreed 100% stocks was a bit to volatile regardless of the long-term objectives, so we took a more balanced approach -- about 65% stocks and 35% short-term bonds, with the equity side all-value and more in small than large (40/60)-- so an expected return somewhere north of 100% TSM with less short-term fluctuations.

For them, it was great diversification: if stocks>bonds, they'd do well. If stocks<bonds, but small>large and/or value>growth, they'd do well. If none of that happened, then it wouldn't have mattered if they had asset class balance or everything in LC, but the bonds would have earned something and still enabled them to leave a reasonable bequest.

Hope this helps.

Eric
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Re: Is now the best time to accurately assess risk tolerance

Postby Blues » Thu Mar 14, 2013 1:40 pm

Thank you, Eric, for sharing your perspective. :beer

(So as not to derail the thread, I'll send you a reply via PM.)
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Re: Is now the best time to accurately assess risk tolerance

Postby pkcrafter » Fri Mar 15, 2013 7:34 pm

Browser wrote;
I'm among those who have been unwilling to increase my equity allocation up to the level I think it "should be" based on evaluating my need, willingness, and ability to assume equity risk in my retirement portfolio. It's primarily because I'm nervous about stocks based on the volatility and poor returns since 2000 and the big run-up since 2009 that seems to me to be based more on extreme financial engineering than fundamentals.


Browser, I don't mean to single you out because you are not going to make a mistake; however, I would like to point out a couple of things that do get lots of investors in trouble and maybe they can see themselves. What you are doing is trying to rationalize something that would go against what you believe and can tolerate. You are nervous about the market run-up and you think it's based on financial engineering. OK, but this is why it's useless to try and time the market--the market may rise for no reason we can see, or it does not go up when everything says it should.

On the one hand, my reluctance to invest as much as I think I '"should" in stocks might just be a recency effect. But on the other hand, I began to ask: shouldn't one's "true" risk tolerance be based on how you feel when your gut feels that equity risks are high?

You believe equity risk is high, really? Here's a chart of the VIX (S and P volatility index) and the
S and P 500 index. Notice that the VIX is historically very low, and when it's low investors interpret this as no market risk and they get confident! Also notice the movement of the S&P 500 index. Again, trying to rationalizing what isn't rational.


Image

Maybe my true risk tolerance is actually what I'm willing to invest in stocks now, and I've been kidding myself about what it "should" be?


No, you are kidding yourself right now. You are going to some length to convince yourself that just maybe you should have a higher stock allocation.

This might actually be the best time to reveal my actual risk tolerance going forward, and I should just recalibrate. What do you think?

Your true risk tolerance is not tested in a rising market, but I acknowledge your enterprising attempt to talk yourself into a higher stock allocation. Stay the course. :sharebeer

Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.
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