Thoughts and observations for those investing on their own or contemplating doing it themselves.
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Friday, September 24, 2010
Can You Stand the Heat?
The single biggest hurdle for the DIY investor is handling emotions. Depending on the volatility of the market and the size of the portfolio, investors translate a portfolio downdraft into losing the equivalent of a new car, a nice vacation, or their kid's college tuition over a short period of time. Second guessing then eats away at the DIYer psyche. This also works on the upside. After a good week or month, you can't help but focus on the fact that, if you cash in recent "winnings," you can take the profits and buy a big screen TV for every room in the house. The next thing you know you're in la la land dreaming of the things you can get. That's until you run head on into the next 4 x 4.
The away around all the angst ( at least according to those who have opined on the sub market performance of individual investors) is to get a plan and pretty much stick with it through thick and thin. This requires careful thought on how to allocate assets (what percentage to invest in each asset class) among the major asset classes. A truism of the investment world is that this decision is a primary determinant of long-run performance. In previous posts, I have examined questionnaires and quizzes to provide some guidance in arriving at appropriate percentages. I have urged readers to consider how they have reacted in past volatile markets - of which we have had plenty since the start of the decade. How did you feel when the S&P 500 reached an all time low in 2007? How about in March of 2009 when it hit the bottom after free falling for 15 months? Did you hold in, capitulate, or see it as a buying opportunity of a lifetime?
Analyze your feelings and behavior during volatile markets, and it gives you excellent feedback on your capability for taking risk. Also, take into account that, when you answer risk tolerance questionnaires, you are somewhat biased. Answer the same questionnaire in late 2007 when the S&P 500 has had a good upside run and then again in March 2009 when there was "blood in the streets" and you'll come up with different assessments. You'll score higher as a risk taker after a positive market environment.
The bottom line is that personal risk tolerance isn't a fixed immutable number, as is sometimes projected. The more times we venture out of the cave without running into a woolly mammoth, the more of a risk taker we become and vice versa.
An excellent discussion of the influence of recent markets on perceived risk tolerance is covered nicely by Jason Zweig in "Your Money & Your Brain" - a must read for every DIYer.
Posted by Robert Wasilewski at 6:46 AM
Labels: DIY investing, Risk tolerance
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In my case, profits are reinvested in the "business". I treat my DIY stock portfolio as a business. No taking out money for a new TV, not even for a lunch at McD.ReplyDelete
No problem with my discipline as you may have noticed I love being when markets are capitulating.
Great post DIY. Actually, I just got Jason's book. I will be reading over the next few months. (I can't wait.)ReplyDelete
Being an Alfred E. Newman (What! Me worry?) type of investor has its advantages.ReplyDelete
You're 100% correct on this one. The biggest enemy we have is the person we face in the mirror each day. To do well with money, you can't care too much about it. Perhaps that's a paradox, but I think it's true. Set a solid plan and don't get swayed by what's happening. Just keep the plan going.
I also liked your previous post about the annuity. If it's with Vanguard or TIA Cref, it can be a good deal---one that can replace a pension, and in many cases, can be indexed to inflation.
Here's a curious question for you Robert. If a 40 year old wanted to buy an annuity worth $1 million, what percent would she be given, indexed to inflation? My guess is that it would be lower. Any ideas?
I wanted to echo the previous comment "The biggest enemy we have is the person we face in the mirror each day." We are both the problem and the solution, which is quite empowering.
Dealing with the emotions during the down times can be incredibly challenging. I did re-evaluate my risk tolerance based on what I observed other people lose. I realized that I was more conservative than I initially thought.
Thanks for an another interesting post.
Thanks for the comments everybody. I am encouraged by the number of young people on line who understand the importance of buying and staying invested in down markets.ReplyDelete
re: FC... Zweig is a must read. Here's his site:
I am actually about one-third through "The Snowball" the Alice Schroeder book on Warren Buffett. I am really enjoying it!
re: Andrew I use a basic calculator that unfortunately doesn't have an inflation rider. It is at http://www.immediateannuities.com/
In your example the big factor is the age of 40. The longer you wait the bigger the payout. Just like Social Security in the U.S.
Half the battle has to do with the the mindset of the investor. Selecting specific investments only becomes valuable when it's within the context of a disciplined, emotionally-controlled person.
re: Dividend Monk Well said.ReplyDelete