Balance the Risk Equilibrium
Top 5 of the Week of January 7th
Beginning our Top 5 this week, Preston McSwain—writing for Enterprising Investor—considers the problem with repetition. A Wealth of Common Sense’s Ben Carlson discusses the serious returns you can get just by making small improvements. And Michael Kitces on his blog, Nerd’s Eye View, looks at balancing clients’ risk tolerance levels.
Blogger Daniel Solin examines the flaws in our perception of risk. And from ETF.com, Larry Swedroe reminds us of the importance of Warren Buffett’s famous insight, “Success in investing doesn’t correlate with IQ. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people in trouble investing…”
Repeat Until True
- Humans find anchoring to repetition a built-in ability, it’s better known as availability and frequency bias—we become convinced when we hear something over and over
- While we’ve all heard the investing line that, “Past performance is not indicative of future results” we still anchor to historical precedence
- Capitalizing on this, some private equity funds make repeat outperformance claims—this does not make them true though
Think Big, But Start Small
- For younger generations, it’s difficult to commit to regularly saving money because the impact of not doing so is a long way off—student loans, rent, and avocado toast though are here and now
- The way to overcome this is to turn saving into a habit of self-improvement by starting small and automating it
- Once you get into a rhythm, you can begin improving on the amount you’re putting away so that you’ll see some serious returns thanks to compound interest in the future
Balance the Risk Equilibrium
- As a financial advisor, it’s typical best practice to establish a client’s risk tolerance before making portfolio or investment recommendations
- However, that doesn’t always align with being able to achieve the same investor’s goals, as not everyone is able to deal with the level of risk needed to realize appropriate returns to match those goals
- In such a case, whether you’re authoritative or accommodative in these situations is less important than helping a client adjust their goals properly
How do you deal with clients’ changing risk levels? Share your comments in the section below
Untrustworthy Risk Perceptions
- Humans (investors included) base a lot of their risk decisions on a single defective assumption—that logic and data are persuasive
- Behavioral finance research demonstrates that emotions overrule data, so we decide based on emotions but justify that we’ve made such a choice based on data
- We are terrible for our unbalanced misperception of risk too, and we tend to let familiarity of risk distort our perception of it—use these insights to make more informed evaluations
“Temperament Trumps Intellect”
- Controlling your temperament is what allows you to dismiss the “noise” made by others in the market and stick to your well-thought-out plan through good and bad
- Becoming so disciplined involves understanding risks, knowing enough investment history to avoid repeating it, and ignoring ‘expert’ forecasts
- Also, avoid constantly checking your portfolio, don’t go beyond your risk tolerance, and realize that even good strategies won’t always yield great returns
Top 5 of the Week is a summarized collection of financial investment articles that we like and think you might like too. Having written thousands of pages of equity strategy and company research between us, we understand the allure of the ever-changing world of finance. Investing is an art form—and like everything, something you can work on and improve at. There are some excellent writers out there on the finance web, some offer a running commentary on today’s market, some are doing research, some have tips on how to Become a Better Investor, and some just lift the cloud of fog behind a lot of financial jargon. Each week we will keep you up to date with the top 5 articles worthy of your attention.
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