You Probably Are Not as Risk Tolerant as You Think You Are….

NEW YORK, NY - DECEMBER 17:  Irving Picard, Se...
NEW YORK, NY - DECEMBER 17: Irving Picard, Securities Investor Protection Act Trustee, speaks as Preet Bharara, U.S. Attorney for the Southern District of New York, looks on at a news conference announcing the recovery of $7.2 billion in the Bernard Madoff Ponzi scheme December 17, 2010 in New York City. The widow of Florida philanthropist Jeffry Picower agreed to return the entire $7.2 billion Picower received from investing with Madoff. The funds will be distributed to the victims of the fraud. (Image credit: Getty Images via @daylife)

Many times, particularly prior to 2008, investors would look at the performance numbers of a more aggressive portfolio and choose it. Apparently their focus is on the positive performance and neglected the potential loss. I call this performance bias. Investors only envision the positive performance happening to them.  They can retire early, save less, become rich.

When asked if they could stand a 25% drop in their portfolios enthusiastically answer, “Yes, absolutely!”  When they actually lose this amount and see real dollars melt away in their portfolios, they are gripped with fear and panic. Inevitably, this leads to the inappropriate behavior of selling at market lows. Beware of false bravado. Recognize your tolerance for losing real money when building your portfolio.

Dalbar Inc. is an independent research firm that studies investor behavior. Each year they look back 20 years to determine how well investors are doing. On criteria is the investor must have at least $100,000 invested. This years’ study ending December 31, 2011 resulted in the following

  • S & P 500                               7.83%
  • Average Equity Investor       3.49%

This poor performance is primarily caused by the investor selling in a panic when the market goes down. It could be the European crisis or the Tsunami in Japan, or Bernie Madoff and on and on. No one can predict, including myself, when the European crisis will end, but it will end. No one can predict when the next crisis will occur.

Successful investors will use down markets as an opportunity to rebalance their portfolio. Sell the better performing components and buying the buying the poorer performers. Buy low, sell high. What a concept.  This requires working with a fiduciary advisor or investor coach if you will.

If your current advisor/broker/agent allows you to sell in a panic, watch out. These are called facilitators or simply salespeople. They make money when you move from one product to another. They at times will feed your fear.

A true advisor will help you determine your goals and develop a portfolio with the proper risk level.  You should be properly educated to understand that risk happens. If you develop a prudent portfolio and remain disciplined to that strategy you will succeed over the long term.

You should own equities….globally diversify….rebalance.

Please comment or call to discuss how this affects you and your financial future.

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