Monday, March 16, 2020

It’s Too Late to ‘Re-Evaluate Your Risk Tolerance’

It’s not easy to know your true investment risk tolerance. Fred Schwed explained this problem wonderfully in his book Where are the Customers’ Yachts?:

“There are certain things that cannot be adequately explained to a virgin either by words or pictures. Nor can any description that I might offer here even approximate what it feels like to lose a real chunk of money that you used to own.”

Now that the stock market has tanked and investors are learning what it feels like to lose money, experts like financial planner Jonathan Bednar are saying “This is a great time to re-evaluate your true risk tolerance,” and “If you are nervous then you may be taking on more risk than you are really comfortable with and should rebalance into a more conservative portfolio.”

This advice amounts to “sell stocks while they are low.” The best time to figure out that you don’t have the stomach for a stock market crash is while prices are still high. It’s now too late to reduce your stock allocation without permanently locking in losses.

Unfortunately, when stocks are soaring it’s far too easy to convince yourself that your risk tolerance is high. So maybe we need a different strategy. Perhaps we should record videos of ourselves saying how we feel after stocks crashed, and set a calendar reminder to watch this video annually. The next time stocks are soaring again, maybe the video will help us lighten up on stocks while prices are still high.

In the meantime, we have a choice to make. Either sell stocks and permanently lock in losses, or try to gut it out until the recovery and reduce our stock allocation at better prices.

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