Day 81: A True Test of Risk Tolerance

If you follow investing topics, or read up on personal finance, you will often hear about risk tolerance, which is the concept that as an investor you want to choose investments within a level of risk you can tolerate. You want to take enough risk that there is reward potential, but not so much that you are tempted to bail on your investments when the going gets tough (ie sell in a panic), or that you suffer inordinately in times of volatility. In a perfect world, your investments let you sleep soundly at night. You appreciate the work your investments are doing for your financial well-being, but you don’t worry about them too much.

I had an insight this morning about our risk tolerance. First, an admission: recent market volatility (in both stocks and bonds) has been a tad, um, annoying (?) and even disappointing (?). Despite my enthusiasm for growing share ownership versus focusing on overall portfolio balance, it hasn’t been fun to see our balances go down (or at best, flatline) this year. I even experienced some guilt (regret?) about buying certain funds that dropped significantly (long bonds, anyone?).

The important thing is that, despite the annoyance or discomfort, I am confident I can tolerate these conditions. I don’t have to like it. I can ride it out comfortably enough. I trust our plan and am optimistic that it will work out in the long run. So does my wife. She admits to being loss-averse, yet reassured me just today that she is fine with our set up.

Based on these things, I am reassured that our assets are properly allocated to our risk tolerance :). Here’s the key: being inconvenienced or a little uncomfortable is very different from being in a panic!

This insight is giving me a personal understanding of what risk tolerance is about. It’s not that one enjoys volatility, or the risk of loss. It’s about being able to tolerate a given level of risk while maintaining a sound mind and while not being overly concerned.

That’s a true test of risk tolerance!

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