Understanding risk tolerance
FOMO (Fear of Missing Out)
Business: Money Matters
By Founder and Managing Member Christian Kruse, CFP®
Despite the unease many of us feel due to inflation and the high cost of living, stocks have performed well and some, like Nvidia, have exploded in value during the recent AI stock mania. This has raised comparisons of the tech boom of the 1990s that ended in 2000-2001.
Understanding your risk tolerance is considered one of the most important elements of investing. During bull markets we often feel the only volatility is to the upside, and forget painful lessons learned from years like 2008. Why? Our brains are wired this way. We tend to focus on short term emotions like fear and greed and forget our long-term goals like retirement and financial security.
Emotional Risk Tolerance
The emotional component of risk tolerance can have far more influence over your decisions than your financial capacity. Emotions are powerful enough to override logic and can drive people to decisions that may not be aligned with their overall financial plan. This response is powerful enough to lead people to flee the stock market en masse after it’s already fallen and draw people into a raging market near its peak. In both scenarios, individual risk tolerance is being skewed by emotions, which leads to divisions that do not reflect their long-term strategy.
Emotions are an important element of risk tolerance and shouldn’t be overlooked. Understanding that emotions are reactionary mechanisms that tend to flare up over short-term events may keep you in check when looking at the context of your long-term strategy. It would be hard to not lose sleep if the market suddenly crashed. It’s a natural human response. But, realizing that, you don’t have to act on those sudden emotional responses, especially if it works against you in the long run.
Focus on the Long-Term
It’s generally believed that people who focus primarily on the markets will experience a roller coaster of emotions. Because of this, their confidence may be tied to their market performance. On the other hand, investors that focus on their long-term strategy need only to have confidence in that strategy. If the plan is well-balanced, diversified, and managed through proper rebalancing for evolving risk tolerance, short-term market events may have less impact.
At Better Planning and Investing, we start with a basic financial plan before we even begin discussing how to invest. This is why we offer a no-cost initial plan. We understand that long-term average returns are determined not by short-term market conditions, but rather long-term average returns. Knowing this, we can focus on the asset allocation that allows you to sleep at night while participating in market returns.
For this reason, we love low-cost index funds for large asset classes, and focus on having the right amount of cash not just to pay expenses, but to take advantage of market downturns when they occur. Success in your financial goals means having a plan that recognizes when you need your money, not just how much.
To learn more, visit BetterPlanningLLC.com and book a no-sales introduction call to learn more about our process and if it’s right for you.
Financial Advisors do not provide specific tax/legal advice and this information should not be considered as such. You should always consult your tax/legal advisor regarding your own specific tax/legal situation. Separate from the financial plan and our role as a financial planner, we may recommend the purchase of specific investment or insurance products or account. These product recommendations are not part of the financial plan and you are under no obligation to follow them. Life insurance products contain fees, such as mortality and expense charges (which may increase over time), and may contain restrictions, such as surrender periods. Better Planning and Investing LLC is a registered investment advisor in the state of Oregon.
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