You Are Probably Not As Tolerant of Risk As You Think You Are

The greatest risk to investors is not found in any given portfolio, not concentrated in any particular industry, and not originating in the advice of any particular pundit. The risk that has the potential to do the most harm to investors is something that all of us have to fight in our own journey of investing. It doesn’t come from without; it comes from within. The greatest risk to investors is their own overconfidence.

When asked if they could stand, for example, a twenty-five percent drop in their portfolio, many investors can immediately answer, “Yes, absolutely! No problem!” However, when they actually lose twenty-five percent of their portfolio, and the start to see the real dollars draining away one by one, fear and panic grips them. Suddenly, they are singing quite a different tune. When their overconfidence is shattered, they tend to turn to erratic behavior. The anxiety prompts them to begin selling at market lows. In the world of investing, there is nothing more dangerous than false bravado.

There are countless stories about how overconfidence can lead to downfall. We all know the story of the tortoise and the hare. The tortoise and the hare agree to a race. Thinking that he cannot possibly be beaten, the hare takes his time–stopping to relax and take a few naps along the way. Before he knows it, though, the tortoise has actually passed him and ends up winning the race. Most of us think the takeaway from this parable is, “slow and steady wins the race.” But, the real takeaway is that overconfidence loses the race.

Many of us rush into investing like we’re the hare. We think that we’re unbeatable, that we’re bulletproof. We know all of the stories about people who get sucked into making bad trading decisions in the market, but we never think that it will be us. We as investors say we’re too smart for that. We’re too rational. The truth is that we’re human beings just like everyone else. When we start to see ourselves losing real money, we’ll likely react the same way as anyone. In despair, we’ll lose all sense of rationality and start selling off our portfolio in a desperate attempt to recoup our loses. It happens to the best of us, no matter how smart we think we are.

The important concept to learn is before you jump into the world of investing is to recognize your vulnerabilities. The market is going to have ups and downs and, during the down times, you will be challenged. You will see your portfolio drop in price, and you’ll want to get rid of all those “bad stocks.” But, just hold on. In this case, “slow and steady wins the race” is the lesson you’ll need to learn. If you can approach investing with a little less overconfidence and a little more level headed-ness, you’ll no doubt have the patience to weather the storm. If you need any help understanding how to tailor your attitude toward success in your investing, feel free to reach out to us for a free consultation. We want to help you discover the approach that doesn’t just make you feel good about your investments, but also gets you the results you need despite the volatility of the market.