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I remember when I managed 401k plans and conducted educational programs for employees trying to discuss risk tolerance. I concluded over the years few people actually understood their own risk tolerance, including me. It was easy to claim being willing to take risk when things were going well, but that confidence quickly disappeared if their account dropped three days in a row.
To help, we built, with “expert” help, three funds – a mix of the mutual funds and Guaranteed Investment Certificate or Contract (GIC) offered by the plan. They were labeled Conservative, Moderate and Aggressive. The Aggressive fund had no GIC and the Conservative fund a good portion GIC. All three automatically rebalanced.
We put a great deal of effort in explaining it all and what it was intended to accomplish. A great deal of wasted effort. They were either not used or misused with many people investing in more than one fund, sometimes all three. I think workers were overconfident with their ability to tolerate risk.
The University of Missouri has a good online and free risk tolerance test. You factor in age, income and decision make based on investment knowledge.
I took it and came out “average/moderate.” I’m not sure exactly what that tells me though. I know I’m not a risk taker, but average. I don’t like being average. I wonder what the results would be if I were 35 instead of 81.
When it comes to money, money needed to live on in the future, I think most of us have a lower risk tolerance than what we may tell ourselves.
Once a year Connie and I go to a casino for a couple of hours with the slots. We have a fixed amount of money we keep separate – about $200 – if we win, we add it to the pot. Over several years the pot hasn’t been depleted, but barely grown either. We limit our risk and since we play only nickel machines, we limit potential reward as well. I recall the thrill of a win on one of those slots with lots of action, sounds and such. And then, inevitably, the odds catch up to us and we slink away after hitting our risk limit.
Betting on ones financial security is a lot different and trying to meet goals of growth and safety is not an easy task. In some cases extreme risk tolerance in either direction may make the goal more difficult.
I’m thinking moving between aggressive, moderate and conservative style portfolios consisted with age or the years to retirement is what most people are thinking.
My score on the assessment was 31. Wife and I are able to be a bit more risk-tolerant due to our pensions which more than cover all our expenses. Most of the questions on the assessment I found to be fairly easy to respond to, but there were a few that caused me to think a bit.
I scored 27, about what I expected.
I was almost completely invested during the 1987 crash, the dot-com crash, and the 2008 crash. In each case, I did absolutely nothing other than normal rebalancing with my investments.
I’m 75 now and it’s highly likely that I have more than enough to last the rest of my lifetime. Rather than using a fixed percentage for each category of my investible assets, I put that I expect to need in the next 5-10 years in bond index funds and cash and the rest in equity index funds. Contrary to typical advice, I’ve increased the percentage in equity funds over the course of my retirement. Most of what is left when I die will go to charities.
I scored 27, high end of moderate risk which is about right.
I do not believe we really know our risk tolerance until we experience a bad bear market like the 2008 great recession. I was planning to retire at the end of 2008 but was able to work 2 more years to buildup my retirement nestegg. I took a hard hit to my portfolio and it took a while to recover.
One thing I learned when I retired was that my risk tolerance declined because I no longer had my human capital working for me. Despite lots of research on retirement, I never read this anywhere.
Interesting risk tool-I scored about where I expected at the high end of the average/moderate category. If my wife took it, I’m pretty sure her score would show less risk tolerance. This difference has led to several discussions, most of them productive. 🙂 It’s also one of many reasons why we have a financial advisor. I don’t think I am likely to forget my 401k becoming a 201k in 2008 and taking 5 years to recover even though I kept contributing and even increasing my contributions. We a have a safety first retirement income strategy. For last 7 years in early retirement we have been 50/50 but last year after buying QLACs our risk capacity increased so we moved to 60/40. Our plan is to move to 70/30 in a couple of years when we move start delayed SS and I turn on conservatively invested deferred comp distributions. A rising equity glidepath.
We are currently 45/55 for our allocation. Our target allocation is actually 50/50, but a Christine Benz article in Morningstar a few months ago calculated that a portfolio of as little as 30% (I believe) bonds is expected to produce a similar return with less volatility due to increased interest rates and an over bought equities market.
In a few years when we are both 70 and claiming Social Security the bond-like payments along with my small pension should take care of our budget. At that point I plan on gradually (maybe 5% per year) increasing our percentage of equities to a yet undetermined target. The study of what target allocation to reach will occur in the year leading up to the change.
I think risk generally is pretty poorly understood. I’d argue that the main problem for many is that they don’t take enough risk – that CD or assured bond or flim flammy vehicle that promises upside while limiting downside. Unlikely to long term match the performance of some basic equity indices.
Much of my preparation for retirement has been trying to prepare myself fully for the reality that there will be down days, months, years even for my portfolio yet as the money is there for 30 (or hopefully more years there is plenty of time to recover. And if I reach say 85+ sitting on a decent pot so what if I lose a bit then – there will be a point where my investments will almost certainly outlive me. I think I’m getting there mentally.
The real risk with risk is that you spend so much time fretting about it that it affects your quality of life. Or do so much tinkering to attempt to mitigate it you destroy value.
None of this is is advocating of course that everyone should HODL on the latest meme stock or liquidate everything into crypto etc .
Risk probably is misunderstood, but for many it is scary.
People fear the cost of health care and sometimes over-insure and guarantee the fixed cost of high premiums, but the reality for most people is minimal risk in any given year.
This sparks some interesting thoughts Dick. I don’t particularly like market drops, but I’ve yet to do anything truly damaging. During the Great Recession, I was just mildly uneasy, because I knew the opportunity was also great and I was a long way from retirement. I bought all the stocks I could. I knew I should feel excited, but I just couldn’t generate genuine excitement.
In 2020, I again felt the loss, but the turnaround happened so quickly it didn’t last long. And again, I bought stocks, chasing the low prices. But I came into that year thinking about working several more years, not about retirement.
In 2022, my thinking had changed somewhat. Factors were in play that I thought might force at least a partial retirement. I had moved more money into bonds a few months before the big fall. I didn’t shift back to stocks, because I was focused on keeping a reserve for income if I needed it. But I did keep up my regular buying of stocks, which is a good portion of earnings.
So I would say that my risk tolerance is somewhat influenced by years until retirement. I could say a bit more, but I’ll think about it awhile longer.
According to that assessment I have a high tolerance for risk. Which matches my own feelings.
What I am, I guess that both my wife and I feel this way, is DEBT averse.
We don’t seem to mind being over-invested in stock mutual funds (as is recommended for our ages) but we HATE owing money.
Very interesting result. I have a high risk tolerance according to the test. That wouldn’t have surprised me 10 or 15 years ago, but now I would consider my investment style at this point in my life to be quite moderate in terms of risk. I guess it’s nice to know I still have that aggression in my nature!
That U of MO risk assessment tool is the best that I’ve seen. I scored a 25 (average/moderate) and my portfolio AA has been 50/50 for 14 years now. Guess I’ve known my proper risk tolerance for some time, eh?
My risk tolerance score is 30, above average.
In my Vanguard fund I can see what my cumulative return on investments is on a monthly basis over the past 10 years.
I have only had a positive net return since 4/2016. Since then I have experienced three significant decreases in those returns.
1) 10/2018-12/2018 48% drop
2) 2/2020-3/2020 58% drop, by the time I had experienced our next loss in 9/2020 we had a 301% increase from the low point, and our total returns were greater than the low balance by 24%
3) 8/2021-6/2022 35% drop.
Since 9/2022 my last low point our returns have doubled.
What did I do during these big losses?
Nothing, except during COVID buy stock mutual funds (at different set percentage drops in the market) with money I had inherited in 1/2019 (which I had been holding in a money market account as at the time the market seemed “frothy”).
Lessons learned over the years from two sages:
John Bogle,”Don’t just do something, stand there”.
To quote Warren Buffet,”be fearful when others are greedy and to be greedy only when others are fearful.”
I was fortunate to experience two 50% stock market downturns. One was during 2000 to 2002 and the other 2007 to 2009. I say “fortunate” as I learned quite a bit about myself during those periods. It wasn’t fun. At age 57 I had no pension, no house and my retirement accounts fell to about $8,500. I made a serious re-evaluation. Five years later when the 2008 downturn occurred, I took the opportunity to re-configure my retirement accounts and bought equities. These incidents taught me the value of cash, while some prefer to say “cash is trash”. Holding cash was difficult when returns were a fraction of a percent. I also became cautious when bond ETFs yielded almost nothing as I felt I wasn’t being adequately compensated for the risk, no matter how slight. Since December 2019 Vanguard’s BSV is still down about 4.1% and BND is down 14.2%.
I just copied and pasted my original post in an email to my children. I realized it might be a valuable lesson to guide their investing futures.
I hope your good fortune continues. What about a 2007- 2008 type event or 1987. Would your tolerance hold steady? Are you retired?
’87 was my crash course. I haven’t flinched since.
I’m not sure I was investing in ‘87 as we had a two year old, and had just bought a house. I was investing in ‘07-08 and just kept plowing a regular portion of our paychecks into our 401K. Reading Vanguard articles, especially from the Captain of the ship, John Bogle, kept me from jumping ship! After all stocks were “on sale” and we were more than an decade away from retirement.
We are retired (‘19 and ‘20), and living off our retirement assets until claiming SS at 70. We have 2 years of cash and 8 years of bonds, mostly short term/TIPS. Our portfolio is 10% cash, 46% stock (33 US/13% international), 44% bonds, so well diversified, so even if the market drop precipitously our losses would be limited. As I have written before if our portfolio drops to an admittingly random level we will have my wife, who is now at her full retirement age, claim SS to limit withdrawls.
Overall our 10 year return is 7.1%, which I am satisfied with because we have “enough!
My risk tolerance according to the assessment is what I believe it to be.
I wonder if that’s unusual?
Mine too, I was surprised…not really. I’ve always been conflicted conservative wishing I was not.
Most of us learn what our actual risk tolerance is over time. Bernstein, Jonathan and others have written that in addition to our tolerance of risk, we must consider our capacitance and our need to take risk. This helps explain why one’s portfolio allocation does not necessarily correlate with one’s risk tolerance.
Interesting place to find a risk tolerance assessment!
I took the university of Missouri test. It indicated that I have an “above average” tolerance for risk. It is what I expected. However, my actual approach is that of one who is less risk tolerant. This is reflected in our 65/35 portfolio.
How do you reconcile being above average and yet investing more average😁
Yes, I could take more risk but choose not to. G is less risk tolerant than I am; psychologically I am willing to take on more risk, she is less so. Looking at our risk capacity, which is more about our financial ability to endure losses, we don’t have a need to take on more risk. So why should or would we? One of the lifetime planning tools we use indicates that we are sufficient to fund all of our lifetime goals and expenses. Other tools provide similar results. I stress-test all of these and the result are acceptable.
Over the years I have moved from an aggressive portfolio to one that is more cautious. I’m retired and taking RMDs so I have a cash cushion. G and I periodically discuss our risk capacity and tolerance. For example, our individual reaction to a 10, 20, or 30% decline. This has been useful. There is an emotional component, and then there is a possible lifestyle alteration to consider.
An emotional component for sure. When think about your reaction to say 30% decline do you discus what lifestyle changes if any would be required?
I stress test our portfolios. There are other things of importance. From the perspective of lifestyle costs, for example, what if there were a 30% portfolio/market decline or a 20% reduction in social security benefits, or both? Less dramatic, what if the long term rate-of-return was less than the usual, say about 4.5% for equities (which some anticipate), or inflation is above a long-term average of 3.6%? What if one of us lives longer, say until 97, or 103? What if our Long Term Care insurance company defaults? Etc. In the worst case, we could sell a house, reduce expenses, etc. We do have a method to reduce living expenses. We have no debt so that is not an issue.
I took the test and just made it into the “above average tolerance for risk” category, which surprised me. I have now made it through three draw downs without making any change to my portfolio, although I should no doubt have bought. My portfolio, at age 77, is 50-45-5, and I have no plans to change it.
Some people talk a good game, but when the going gets rough they’re the first ones making a panic phone call to their advisor, or perhaps HR. I call them white knuckle bulls.
Very true. I remember during the crash back in 2008(?) so many workers panicked and moved account to GIC and locked in their losses.