Announcement

Collapse
No announcement yet.

Finance: Risk Tolerance and Risk Perception

Collapse
X
Collapse
 
  • Page of 1
  • Filter
  • Time
  • Show
Clear All
new posts
Previous template Next
  • #1

    Finance: Risk Tolerance and Risk Perception

    This article was passed to me and I thought it was worth sharing. It's about your risk perception influencing your investing, not so much your risk tolerance: http://www.kitces.com/blog/archives/...rceptions.html

    I liked this analogy:

    Perhaps a non-investment example will help. You're driving down the highway. The speed limit is 65mph, but you're driving at 72mph. Which means either by deliberate or subconscious choice, you've decided that you're willing to risk a modest speeding ticket, in exchange for getting to your destination a little faster. You've made a behavior decision about the risk-return trade-off, based on your risk attitude. Now, let's assume that as you're driving down the road, you actually drive by a police speed trap. Relieved, you see that the officer is not pursuing you. Nonetheless, the driver reaction is virtually always the same - we start driving a little slower for a while. Reminded of the fact that speed traps really are nearby and there could be another one soon, we perceive the risk of getting caught as elevated, and modify our behavior accordingly. It's still true that the driver is willing to go 72mph in a 65mph zone in exchange for a low risk of getting caught; what's change is not the driver's attitude about risk, but his perception that the risk of getting caught might be a lot higher than he first realized.
    Kung Wu say, man who read woman like book, prefer braille!
    Tags: None
  • #2
    It's not as easy as it sounds, but some make it a lot harder than it needs to be. One needs to understand at least a few principles. 1) Understand your level of Financial Greed and level of Financial Fear, 2) Sell High, Buy Low. These 2 principles can be really difficult for some to mesh together. I know people who, if they are in a big buying mode, I should sell and if they are selling, I should buy. They are as predictable as the sun rising and setting. They cannot grasp how Principle #1 applies to themselves which cause them to ignore Principle #2. They allow their greed to control by staying too long and/or too heavily in what was an up market. Their greed continues to control by ignoring what is happening and giving false hope that it will soon recover. Before greed has loosened its grip, they're in a loss position and fear now takes over and they sell at a loss. As markets show strong signs of recovery and growth, fear holds it grip until they cannot stand it and end up buying high. One needs to follow principles, not perceptions.

    I've always looked at "Risk Tolerance" as my current financial stature and goals and what would be reasonable risk/reward for that current stature and goals. There can be great financial risks in either being too aggressive or too conservative. My personal "Risk Tolerance" is a comfort zone. Understanding that if I want to be more conservative than the norm, I may need to up contributions to reach higher goals. Likewise, if I'm more aggressive, I need to be willing to work/invest longer if things don't work out as planned. If one is not willing to do either, contribute more or work/invest longer (or both), goals need to be adjusted.

    Not understanding or not willing to accept reasonable boundaries of the above is where another form of "Risk Perception" (or misperception) can come into play. The perception that I can always throw more money at it and/or just take higher risks and make up for what I've lost. Yup, you might know someone that succeeded financial in spite of themselves. It happens......just probably not for you.

    Comment

    • #3
      Originally posted by ShockTalk View Post
      It's not as easy as it sounds, but some make it a lot harder than it needs to be. One needs to understand at least a few principles. 1) Understand your level of Financial Greed and level of Financial Fear, 2) Sell High, Buy Low. These 2 principles can be really difficult for some to mesh together. I know people who, if they are in a big buying mode, I should sell and if they are selling, I should buy. They are as predictable as the sun rising and setting. They cannot grasp how Principle #1 applies to themselves which cause them to ignore Principle #2. They allow their greed to control by staying too long and/or too heavily in what was an up market. Their greed continues to control by ignoring what is happening and giving false hope that it will soon recover. Before greed has loosened its grip, they're in a loss position and fear now takes over and they sell at a loss. As markets show strong signs of recovery and growth, fear holds it grip until they cannot stand it and end up buying high. One needs to follow principles, not perceptions.

      I've always looked at "Risk Tolerance" as my current financial stature and goals and what would be reasonable risk/reward for that current stature and goals. There can be great financial risks in either being too aggressive or too conservative. My personal "Risk Tolerance" is a comfort zone. Understanding that if I want to be more conservative than the norm, I may need to up contributions to reach higher goals. Likewise, if I'm more aggressive, I need to be willing to work/invest longer if things don't work out as planned. If one is not willing to do either, contribute more or work/invest longer (or both), goals need to be adjusted.

      Not understanding or not willing to accept reasonable boundaries of the above is where another form of "Risk Perception" (or misperception) can come into play. The perception that I can always throw more money at it and/or just take higher risks and make up for what I've lost. Yup, you might know someone that succeeded financial in spite of themselves. It happens......just probably not for you.
      Sage thoughts here.

      I suppose it's just a matter of extending your principles to decide how diversified you want to become, or do you use some technical analysis for that (or some combination of the two)?
      Kung Wu say, man who read woman like book, prefer braille!

      Comment

      • #4
        Originally posted by Kung Wu View Post
        Sage thoughts here.

        I suppose it's just a matter of extending your principles to decide how diversified you want to become, or do you use some technical analysis for that (or some combination of the two)?
        In my book, diversification is a must as long as one does not get too unwieldy and/or outlandish.

        Personally, I don't get very complicated, mostly because I don't want to spend the time required to do that properly. If you trade in individual stocks, one needs to make such endeavors an avocation. I generally don't want to that. If you have a broker, I'd still make it an avocation to understand and follow what is being recommended and why. It will also help you know if he's making moves in your best interest and not his.

        IMO, mutual funds are a more suited investment for the rank and file. Much easier to understand, more flexible, more diversified, and you have real professional investment advisors handling your money that are performance trackable (is that a word??).

        You may already be familiar with it, but the Morningstar Style Box, can be a very nice aid. Personally, I have funds in all the boxes, but percentage balanced to my style of investing. As a note to this box: Funds in the upper left hand 3 boxes are generally considered the most conservative styles, the 3 diagonal from upper right to lower left is moderate, and the lower right hand 3 the most aggressive. Morningstar also mentions "A Global Approach". Keep in mind that funds named "international funds" contain no US stocks. Global or World funds do. In my book, the latter 2 give investment managers more flexibility if needed, but look to see what the maximum is that they can put in any one area or region.

        Comment

        • #5
          Originally posted by Kung Wu View Post
          Sage thoughts here.

          I suppose it's just a matter of extending your principles to decide how diversified you want to become, or do you use some technical analysis for that (or some combination of the two)?
          Have to laugh because I studied with Joe Granville for 6 months
          I have come here to chew bubblegum and kickass ... and I'm all out of bubblegum.

          Comment

          • #6
            Originally posted by kcshocker11 View Post
            Have to laugh because I studied with Joe Granville for 6 months
            Never heard of him but after Googling him it looks like he had some pretty funny seminars.
            Kung Wu say, man who read woman like book, prefer braille!

            Comment

            • #7
              Originally posted by kcshocker11 View Post
              Have to laugh because I studied with Joe Granville for 6 months
              How'd that January 2012 Granville prediction turn out for ya? lol.

              Comment

              • #8
                I had him for a class in tech analysis for my MBA. Also had Dr Linda Boyer who at one time was Pres of the Chicago Mercantile. Never put much stock(no pun intended) in tech analysis. I did enjoy his class though.
                I have come here to chew bubblegum and kickass ... and I'm all out of bubblegum.

                Comment

                Previous template Next
                Working...
                X