In the same article quoted in yesterday's blog (March 2010 Journal of Financial Planning by Bodie, Fullmer and Treussard), the author's stated other traps and fallacies:
"...the false notion that stocks are an effective hedge against inflation, the fallacy of time diversification of risk, and reliance on probability statistics as a measure of risk..."
It is true that in the high-inflation periods of the 1970's and early 1980's stocks did perform poorly, but overall, with mild inflation (less than 4%), the effects are not correlated. The authors state that "...empirical studies show that stock returns are largely uncorrelated with inflation..."
Bodie (1995) shows that "...the cost of this insurance [to insure that an investment will, at least, earn the risk-free rate] increases with the time horizon...and can be replicated by purchasing a put option...prices...in fact increase with the length of the time horizon..."
Though the chances of experiencing declines in a portfolio increase over time, the average ending result still may be higher than just taking a non-stock approach. Never any guarantees either way.
To continue, "...probability theory has strongly influenced...economics...from its 17th century founders, Blaise Pascal and Pierre de Fermat...Pascal...reasoned that knowing the probability of an event was not enough. The consequences of the event matter, too. Thus, risk has two dimensions. One involves the probabilities of certain events. The other involves the consequences of those events..."
The consequences could be not reaching your retirement goal because of being too conservative or too aggressive. Again, either method could be true.
An Introduction
Hi. Welcome to BourGroup and my blog. Phil
Phil Bour is a CERTIFIED FINANCIAL PLANNER(tm) professional since 2004, a Magna Cum Laude college graduate and an accounting professional for over 35+ years. I love numbers, statistics and economic history.
I am also an Enrolled Agent (EA) to represent taxpayers before the Internal Revenue Service and to prepare tax returns.
"Phil"osophy: I believe that you can manage your money on your own (not necessarily through individual stock selection but through mutual funds, ETF's and other solutions) once you receive some one-time, professional guidance. Why pay annual fees when there may be little added value? For additional information, first read the "An Introduction" label at the left. Then move on to others.
Phil Bour is a CERTIFIED FINANCIAL PLANNER(tm) professional since 2004, a Magna Cum Laude college graduate and an accounting professional for over 35+ years. I love numbers, statistics and economic history.
I am also an Enrolled Agent (EA) to represent taxpayers before the Internal Revenue Service and to prepare tax returns.
"Phil"osophy: I believe that you can manage your money on your own (not necessarily through individual stock selection but through mutual funds, ETF's and other solutions) once you receive some one-time, professional guidance. Why pay annual fees when there may be little added value? For additional information, first read the "An Introduction" label at the left. Then move on to others.
Showing posts with label Risk Tolerance. Show all posts
Showing posts with label Risk Tolerance. Show all posts
Tuesday, February 25, 2014
Tuesday, April 12, 2011
The Risk Conversation
According to several studies, individual investors are still fearful of stock (and bond) markets and may be more conservatively positioned than they should be for their age and time horizon. Stocks and bonds do hold many varied and legitimate risks to be considered.
Risk tolerance, though, should not be as much a matter of how you feel about the risks of the markets but rather of your personal:
Risk tolerance, though, should not be as much a matter of how you feel about the risks of the markets but rather of your personal:
- Risk Capacity = your ability to withstand losses; for example, because:
- your time horizon is long,
- your income needs are being met by other sources, or
- your emergency funds are in "safe" money and sufficient
- Risk Need = the amount of risk required to meet your goals and still:
- meet or beat inflation, and
- overcome the tax burdens
Monday, December 14, 2009
Risk Tolerance vs. Risk Capacity
Risk Questionnaires do not usually rate very high with me as I believe that your risk "capacity" (ability to hold on and not access investments that have gone down in value) and your strategy (years of safety required for your particular distribution or income needs) have more weight in deciding how to invest. However, if you are curious as to your "bent" then FinaMetrica is one of the most highly respected organizations to derive some ideas on risk.
Here is a risk profile questionnaire developed by FinaMetrica that normally costs $30 per person but is currently available on Kiplinger's website for free (December 2009 and not sure how long this will be available for free):
www.kiplinger.com/reports/investor-psychology
You can also go directly to this FinaMetrica website and take the quiz:
http://riskprofiling.com/freeprofile/
It may be a starting point, at least, for discussion with a professional planner but strategy still is important as is your time horizon.
Here is a risk profile questionnaire developed by FinaMetrica that normally costs $30 per person but is currently available on Kiplinger's website for free (December 2009 and not sure how long this will be available for free):
www.kiplinger.com/reports/investor-psychology
You can also go directly to this FinaMetrica website and take the quiz:
http://riskprofiling.com/freeprofile/
It may be a starting point, at least, for discussion with a professional planner but strategy still is important as is your time horizon.
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