“Risk comes from not knowing what you’re doing.” – Warren Buffett
In a recent post titled Getting Started: Understanding the Basics of Investing I mentioned there are varying degrees of risk and reward with investing.
There is no once size fits all approach to investing.
Everyone comes at it from a different angle. Understanding what your objectives are and how much volatility you’re willing and able to stomach will help you determine the appropriate approach for you.
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When talking about investment objectives, we focus our attention on a few buckets: preservation of money, current income, and growth. There are some variations within each bucket as well, but some things to consider when determining the appropriate bucket for your situation are age, how much time you have to reach your goal, your stage in life, your financial position, and your individual circumstances.
In general, the less time you have, the more conservative you should be because you won’t have a lot of time to make up for potential losses that may occur.
And if you have a lot of time on your side, you may be able to afford to be more aggressive because you’d have more time to make up for any losses that occurred and you’d be able to benefit more from compounding interest.
A more conservative approach tends to focus on protecting the money you’ve accumulated.
An aggressive approach would focus on growth and not be concerned about volatility along the way.
Peter Lynch, who is considered one of the top investors of all time, said “Everyone has the brain power to make money in the markets. Not everyone has the stomach.”
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When the markets are going up, it is easy to be euphoric about your strategy. When the markets go down it can be hard to look at the big picture. If you are losing sleep about the volatility of your investments, you are probably taking on too much risk in your investments.
Another factor that is helpful in determining your risk tolerance is how much you want to be involved. Do you have the time/desire to research and understand which investments are most appropriate for you? Just because your neighbor is investing one way, it doesn’t mean that is the best thing for you. The most important thing to remember about risk tolerance is that it is individual.
At any given moment, you could go online and find what seems like a million different theories on how you should invest your money.
How do you know which money theory is right for you? How do you cut through the noise?
At a basic level it's possible to have multiple paths to the same end result. There is not a one size fits all approach to investing. Your job is to educate yourself enough to know what could fit into your overall strategy and just let the rest remain as white noise in the background.
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The way to do that is to make sure you understand what you’re buying, understand the risks, and understand the fees. As a whole the financial services industry has confused the masses. If you don’t understand what you’re buying, the risks, and the fees it probably isn’t the right investment for you. Let it be noise. Let most of it be noise.
There are billions of dollars (maybe trillions) that flow in and out of the financial services industry. At the end of the day the talking heads are most likely trying to get a bigger slice of the pie.
Investing is not a hard science where there is a concrete answer.
It is a soft science that deals with people and emotions. The fact is that when economists predict the next Great Depression and financial analysts predict the next great stock, they are expressing opinions. Those opinions are based on data, but the data have one HUGE assumption. That assumption is that they know how humans and their emotions will react to certain events. That assumption in itself has some flaws.
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Nobody can predict with 100% certainty how humans and their emotions will react. And since the buying and selling in the markets are largely driven by humans and their emotions, it is important to realize that economists and analysts are expressing their opinions.
Educate yourself enough to understand your strategy. Understand what fits into that strategy. Understand what you’re buying, the risks, and the fees. Beyond that, let all that noise become white noise in the background that helps you sleep.
