Risk

How to Manage Risk Tolerance

There are things in your life that are permanent and others that change over time. Benjamin Franklin argued that “Some people die at 25 and aren’t buried until 75.” Meaning they are just waiting for their body to catch up. He argued that we establish beliefs early in our lives, and except for our principal occupation and hobby, we rarely change those views.

Many argue that our personalities never change, and they are part of that permanent nature. Research done by Dr. Benjamin Hardy suggests a different perspective. In his new book, Personality Isn’t Permanent, he makes the argument that we evolve due to our environment, things we experience, learn, and other external conditions.

Dr. Hardy joined me on Consider This Program this week to discuss his new book and his previous New York bestseller, Willpower Doesn’t Work. Our discussion turned to a financial topic known as “risk tolerance.”

Risk tolerance is a theory about how much “risk” you are willing to accept in a portfolio at a given time.  In theory, the exercise is designed to help you make diversification decisions. How much should you have in equities? How much in cash? The test is designed to see if you can withstand negative periods.

There are several challenges this test presents in my professional opinion. Risk is not just loss, yet that is the only way the human mind thinks about risk, generally.  Risk is getting something different than you expect. It is a surprising result rather than exclusively negative.

During the last 32 years of my career, we have witnessed the crash of 1987, the tech wreck of 2000, the Great Recession of 2008-09, and now a Pandemic. One would be pretty narrow-minded to say that conditions and environments have not changed. If personality isn’t permanent, then neither should be risk tolerance.

Making emotional investment decisions makes for a significant chance you will be in the poor house. Similarly, not recognizing when conditions change in a material fashion is a path to mediocre results.

The financial services industry is notorious for telling people to “stick to their guns” and trust the market will come back.  “It always has,” they say, and they would be correct, providing you don’t have to withdraw the funds. There is also the pesky issue that markets have had sideways decades, not just years. Growth over 70 years has little to do with your retirement.

Families we serve tend to change their verbiage over time but not their answers on the risk tolerance test. They expect us as fiduciaries to do our part to guide them. Indeed, that is our responsibility. But what about people who are making investment decisions on their own without the help of a fiduciary? If conditions have materially changed, how do you know when you are responding emotionally or in a disciplined fashion? Managing change comes down to a disciplined process that reduces emotions and provides probable direction rather than absolute certainty. What’s your process? Was Benjamin Franklin correct about your investment philosophy?

Disclaimer: Joseph Clark is a Certified Financial Planner™ and the Managing Partner of Financial Enhancement Group, LLC an SEC Registered Investment Advisor. He is the host of “Consider This” found on WIBC Saturday mornings from 6-7a.m. as well as three other Indiana-based radio stations. Joe has served as an Adjunct Assistant Professor at Purdue University where he taught the capstone course for a degree in Financial Counseling and Planning.

Financial Enhancement Group is an SEC Registered Investment Advisor.  Securities offered through World Equity Group, Inc., Member FINRA/SIPC, and a Registered Investment Advisor.  Investment Advisory services offered through Financial Enhancement Group (FEG) or World Equity Group.  FEG is not owned or controlled by World Equity Group.

Joseph Clark and World Equity Group, Inc. do not provide tax or legal advice. For tax advice consult with a qualified tax professional. For legal advice consult with an attorney

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Important Update

Due to health and safety concerns for our families, friends and our team, we have made the difficult decision to temporarily close our offices in Lafayette, Brownsburg, Indianapolis and Anderson until January 4, 2021. Our team will remain available to you by phone and email to continue to offer you assistance with your service requests. Please do not hesitate to contact us with any questions you may have.

Questions? Give us a call at 1-800-928-4001.