Bogleheads: What is your risk aversion when investing?

[EternalOptimist]

How risk averse are you using a scale from "1" (not at all) to "10" (very).

[livesoft]

Maybe give us some examples or a questionaire? I have seen lots of folks with different definitions of 1, 2, 3, ..., and even 10.

[Ice-9]

Since I'm 30% fixed income / 70% equity, I figure I must be in the 3rd decile, so I voted "3".

[nisiprius]

This is one suggestion for some kind of, what do educators call it, rubric--a uniform scoring system.

Go to Vanguard's Get a recommendation page. Some of the questions concern personal situation. It seems to me that three of them pertain to risk aversion.



I've numbered those choices in green. Make your choices, add them up, and... oh, heck... uh, if the result is zero, raise it to 1... and presto! a number from 1 to 10.

[ourbrooks]

I'm a 1 and a 10 at the same time.

For our essential expenses, I'm a 1. Anything which fluctuates in value is unacceptable - no stocks, no bonds. That part of our income is covered by pensions, Social Security, and a life annuity. My answers to nisiprius' questions are Strongly Agree, does not apply because all of my assets are already in the safest things I can find, and Least volatility.

For the other part of our portfolio, I'm a 10; I bought stocks during every downturn in the past 20 years. I intend to do "age in stocks" so that we're 90% stocks when I'm age 90. (If I reach that age with our financial plan somewhat intact, most of the money will end up as a bequest and if my heirs are stupid enough to sell when the market is down, I won't know about it.)

The point is, risk aversion is not just one thing that can be measured on one scale. I'm unwilling to take any risks on money I need for essential expenses but I'm very willing to take risks on my heir's money. Other people are extremely adverse to the risk of inflation so they hold more stocks and fewer bonds. Among the things to be considered are:

1. Is the risk of a permanent loss or a temporary loss? What defines the time limits for temporary?
2. What was the money intended for and in what time frame? Next month's tax bill or retirement 30 years out?
3. What's the risk/reward ratio? Am I taking a 1 in 10 chance of losing all of my money for a 3% gain or am I taking a 1 in 100 chance for a 300% gain?

Answering all of these questions with a single number doesn't offer much in the way of useful insight.

[Sbashore]

I voted 5. I am 50/50 equity/fixed. Although, given my age, circumstances, past actions, I could be more or less.

[longinvest]

With a 100% equity portfolio, I voted 0, yet I do not buy any single stock (only broad market ETFs). Should I increase my number?

[bengal22]

When I ponder risk I just ask myself - What Would Jack Bogel Do?

[gkaplan]

I voted "2." I would have voted "1,"but that seemed too extreme.

[cheese_breath]

Seven. The older I get the more risk averse I get.

[Dale_G]

[quote="nisiprius"]


I voted for #3 in the poll. but I have never understood the rationale of the third Vanguard question listed by Nip.

The moderate volatility selection results in a possibility of a 1,924 gain or a 1,020 loss. The most volatility selection results in a 4,229 gain or a 3,629 loss. Gee, nearly twice the gain, but nearly 3.6 times the loss. Who would pick this if they could add and subtract?

Dale

[EternalOptimist]

I voted for #3 in the poll. but I have never understood the rationale of the third Vanguard question listed by Nip.

The moderate volatility selection results in a possibility of a 1,924 gain or a 1,020 loss. The most volatility selection results in a 4,229 gain or a 3,629 loss. Gee, nearly twice the gain, but nearly 3.6 times the loss. Who would pick this if they could add and subtract?

Dale

This question is just another way to gauge an investor's willingness to trade off risk vs reward.

[letsgobobby]

About a 4 using Nisi's scale. Which I suppose matches up with a 60/40 aa?

[Sheepdog]

"8" because I am almost 80..not enough time to recover a long term drop. But I remain 21% in stocks. I have reduced my bond investment duration as well.

[kitteh]

More interesting would be to see this in 3-D with age as one axis.

[staythecourse]

surprised I am the first to ask what "risk aversion" means??

It would seems most (like the vanguard questionaire) refer to risk as 1 yr. volatility, i.e. dispersion of returns.

Is that what others consider as risk? If so, how would that matter for the long term investor?

Not sure if I have the answer, but the longer I invest the more I start questioning what "risk" is and if what is called "risky" is actually risky for the long term investor.

Good luck.

[WhiskeyJ]

surprised I am the first to ask what "risk aversion" means??

To me Risk Aversion refers to how your stomach feels when your portfolio drops significantly and how you are most likely to behave. If it frustrates you, you dwell on "I wish I 'rebalanced' sooner," you worry a lot about what's next, or you shift your AA away from the underperforming asset class in response, you're risk averse. If you take a robotic approach, "Honey, our net worth has dropped by 42% in the past 3 months but statistically speaking this is completely normal..." or you get a secret excitement by losing money because it's a buying/rebalancing opportunity, and you do rebalance or even shift your AA to overweight the underperforming asset class you're not risk averse.

[DaleMaley]

I think the asset allocation of actual people more reflects their risk tolerance than any questionaire.

Below are the actual AA's per 5 different studies....



As you can see, people's risk tolerance gradually declines as they age.

For Bogleheads, % stocks = 114 minus their age is the best fit line.

[livesoft]

surprised I am the first to ask what "risk aversion" means??

To me Risk Aversion refers to how your stomach feels when your portfolio drops significantly and how you are most likely to behave. If it frustrates you, you dwell on "I wish I 'rebalanced' sooner," you worry a lot about what's next, or you shift your AA away from the underperforming asset class in response, you're risk averse. If you take a robotic approach, "Honey, our net worth has dropped by 42% in the past 3 months but statistically speaking this is completely normal..." or you get a secret excitement by losing money because it's a buying/rebalancing opportunity, and you do rebalance or even shift your AA to overweight the underperforming asset class you're not risk averse.

Dislike of loss or even loss aversion is getting to the heart of risk aversion. I will be unphased when my emerging markets small-cap value fund drops by 50% in value, but if my entire portfolio drops by that much, I am not going to like it at all. I know equities fluctuate quite a bit. I'll guess a 10% downturn in equities happens almost once a year and a 25% downturn happens almost once every 3 years. And most folks reading this should have experienced a 50% drop in equity funds that they have personally owned.

But there is a difference between what specific classes of my equities do and what my overall portfolio does. This is where the Vanguard questions presented by nisiprius fall down for me. I am happy to own something risky, but I balance that with being happy to own something that is not so risky.

So Adrian Nenu's "Asset Allocation Rule" about maximum tolerable loss for a portfolio is helpful to see where one falls on the risk aversion scale:
viewtopic.php?t=40212

[staythecourse]

surprised I am the first to ask what "risk aversion" means??

To me Risk Aversion refers to how your stomach feels when your portfolio drops significantly and how you are most likely to behave. If it frustrates you, you dwell on "I wish I 'rebalanced' sooner," you worry a lot about what's next, or you shift your AA away from the underperforming asset class in response, you're risk averse. If you take a robotic approach, "Honey, our net worth has dropped by 42% in the past 3 months but statistically speaking this is completely normal..." or you get a secret excitement by losing money because it's a buying/rebalancing opportunity, and you do rebalance or even shift your AA to overweight the underperforming asset class you're not risk averse.

This where I differ. I don't see short term volatility as risk. I see not having enough money when I need to draw off my investments to live off as risk. Roger Gibson in his excellent book "Asset Allocation" talks about in the end there are only 2 types of real risk. The short run (volatility) and long run (inflation risk). When you invest one is weighing one vs. the other. By increase certain assets (principle stable vs. volatile) they are decreasing one risk BUT AT THE SAME TIME increasing the other.

So back to my original point is what is RISK for the long term investor?? Having a pit in my stomach is not risk as I am concerned in the accumulation phase. Now if I was retired and reverse DCA or got canned and had to start early withdrawals that is a different story.

If one has a steady job (teacher, government worker, doctor, etc...), high EF, no need for liquidity, and a long time horizon what is real risk?? I don't think one year of dropping 50% is risk. I think not having enough money to retire is risk (this is not even talking about folks living longer and more active lifestyles then ever before requiring more money to live off).

Just some stuff to think about.

Good luck.

[livesoft]

....
I don't think one year of dropping 50% is risk. I think not having enough money to retire is risk ....

So do you not see any relationship between having enough money to retire and one year of dropping 50%?

[baw703916]

This is one suggestion for some kind of, what do educators call it, rubric--a uniform scoring system.

Go to Vanguard's Get a recommendation page. Some of the questions concern personal situation. It seems to me that three of them pertain to risk aversion.



I've numbered those choices in green. Make your choices, add them up, and... oh, heck... uh, if the result is zero, raise it to 1... and presto! a number from 1 to 10.

nisi,

The three hypothetical investments in the third question kind of seem weird. If you take the average of the best and worst returns and call that the "expected return" (because we don't know anything else about probabilities--these are "hypothetical" investments after all, so real market history doesn't necessarily apply) then Investment B actually has the best expected return (absolute, not risk adjusted).

Investment A: $214.50
Investment B: $452
Investment C: $295

So I choose B, not because of the risk level, but because it has the highest expected return. Now if this analysis isn't correct because the returns aren't normally distributed between the two extreme values, then my answer is "it depends", because the problem as stated didn't give me enough information.

Brad

[linenfort]

Permanent Portfolio fan here, so I guess I have a strong aversion to risk.
I like a steadily if slowly increasing amount of total wealth, with minimal drawdown.

[staythecourse]

....
I don't think one year of dropping 50% is risk. I think not having enough money to retire is risk ....

So do you not see any relationship between having enough money to retire and one year of dropping 50%?

Good question and the answer is IT DEPENDS. If your 30 the answer is different then if your 64 and about to retire.

For me the answer in my situation at age 36 is that risk does not equate with volatility. In the rest of the post that you did not snipp out I mentioned two types of risk.
For ME and younger investors the bigger risk is NOT short term volatility, but inflation risk, i.e. the unknown future. In the long run there are MANY, MANY more variables, such as: how long will I or my wife live for? will my wife or I have much higher health care needs then the average? What will taxes be like in the future? What will inflation be like? Will I have ailing parents or deadbeat kids to take care of? What type of social security will there be in the future? Knowing there is no DB program for me in the future only makes it more unknown.

Since a diverse equity porfolio has ALWAYS over come any short term volatility I don't find that as MORE risk then the unknown future. So my point in my posts in this thread is that RISK is not the same for me, as it is you for you, or which will be different then someone else.

Good luck.

[tetractys]

I picked 3 because I can imagine that might be somewhere in the neighborhood of %25 bonds, depending on how one might decide to look at it. -- Tet

[Angst]

It's funny - I think of myself as being quite "risk averse". It's part of my nature, and I rated myself a 7, but at the same time, I have little fear of market swoons and crashes. They're buying opportunities to me, I suppose. They're history, they're interesting, but they're background noise.

Consider the following two individuals:
With all else being equal,

Person 1) Holds 15% Equity / 85% Bonds, and saves 10% of employment income annually.
Person 2) Holds 85% Equity / 15% Bonds, and saves 50% of employment income annually.

I am person 2.
I'd feel more "risky" if I followed person 1's behaviors.

[grabiner]

I chose 1, as not risk-averse, but it would really be more meaningful to have objective definitions. Every few years, we have a poll of stock allocation versus age, and the typical Boglehead is usually about age-13 in bonds.

And since I am age-35 in bonds with the risk of age-45 in bonds, I am extremely risk-tolerant even among posters in these polls. In most of these polls, I am the most aggressive investor among those still saving for their own retirement; there are some retirees who are 80% stock but who are living off SS and pensions and intend to leave most of that stock to their children and grandchildren.

[ericd67]

I chose level 1. I will retire in 23 years and I don't remotely care what the market does between now and then. Maybe by year 18 or so I'll change my mind and become more conservative.

[MathWizard]

Using nisiprius' definition of risk, I voted 2.
This seems strange because I normaly would call myself risk-averse.

The problem is that I don't equate volatility with risk. I make sure that my expenses are met, and
I have a decent EF. The remainder of my portfolio should grow. Low yielding investments
guarantee that they will not grow very fast.

The premium that you get for the "risk of volatility" is for the fact that you can't get at
the "value" of your investment quickly, because the immediate price may be less than the value.

I estimate the "value" of my index fund as current balance times (current P/E divided by historical P/E).
This is crude, but it moderates times which are outliers. This to me is a measure
of where the price should actually be, and where RTM would take it.

So price is an instantaneous value, while value is the estimate of current price obtained by
using prices over the long term. Maybe someone else who feels the same way will have a better way
of expressing this.