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A Deeper Look at Risk Tolerance

Thoughts for the risk-averse and the risk-tolerant.

Key points

  • Our level of risk-taking manifests in a surprisingly wide range of our choices.
  • It's easy to rationalize our level of risk-taking. Because its consequences are great, it's worth consciously weighing the risks and rewards.
  • Risk-taking can be a way to avoid adulting.
 Mohamed Hassan/Public Domain Pictures
Source: Mohamed Hassan/Public Domain Pictures

A common way we manifest risk tolerance is when investing. That was the case with two of my clients.1

A risk-taking client

A client said something like this:

I haven’t been able to get much of a job, so I’ve taken up day-trading stocks. I’ve been at it for a year and done pretty well, plus I enjoy the game of it and the adrenaline rush. But my wife is begging me to stop.

My response:

Your wife is probably right. The stock market has risen in the past year, so it was easier to do well. But a review of the literature estimates that only 4 percent of day-traders end up making money. Even fewer make more than what they would have on a job.

Even if you day-trade full-time and stay with it through the six-months-to-one-year learning curve, your chances of making 10 percent net on your money are still very low: 8 to 10 percent. Remember, you must subtract the buy-ask spread and the commission cost from every trade. And you will have made dozens if not hundreds of trades each year, so the costs add up.

Even if you’ve fully invested $100,000 for the entire year, and you defy the odds and make that 10 percent, you’d only earn $10,000. You could make more money working in a fast-food restaurant.

Also, you said you aren’t able to get much of a job, and your wife is begging you to stop day-trading. That implies that you’re not independently wealthy. If that’s so, you can’t afford not to make a decent income, let alone to lose your savings.

Then there’s the issue of intrinsic reward. It’s hard to claim that day-trading helps people. Most jobs, even if you’re just making a widget, do.

Finally, there’s the stress. Day-trading is highly stressful, not healthy.

If you want an adrenaline rush, play video games, but it’s wiser to look at why you haven’t landed a good job. Have you chosen a job target that’s likely to yield good work? Have you taken the typical few months of serious job-searching, mainly using your likely most successful method: your network, cold-contacting target employers, or answering ads? When you’ve gotten interviews, have you prepared moderately but not so much that you’re stiff or seem scripted?

A risk-averse client

A client yesterday said something like:

Everyone says you should put most of your savings not in a bank but in a low-cost mutual fund or ETF (a market basket of stocks that you can buy and sell like a stock). So, some years ago, I invested $6,500 in an ETF that consisted of the 500 largest U.S. companies (the S&P 500). I was excited when it went up to $8,000, but then it went down to $6,300. I couldn’t handle the stress, so I closed the account and put the money back in a bank, even though the interest is now just half of 1 percent.

Here’s a paraphrase of my response:

While past performance doesn’t guarantee future results, are you aware that although stocks do decline at times, over time, they have risen far more than if you kept your money in the bank? Unless you’ll likely need the money within a year or so, the standard advice is reasonable: Invest most of your investible savings in a low-cost ETF or an all-in-one mutual fund, which is a blend of stocks and bonds. Try to be patient, riding out the declines.

That said, some people just can’t stomach that risk and/or believe that the future may be worse than the past. Indeed, some people believe the American economy is a bubble ready to burst. No one can guarantee the future, so you may just have to make the bet that you’re comfortable with.

The takeaway

Of course, your level of risk tolerance can manifest not just in investing. Take a moment to inventory the level of risk you’ve assumed, not just in investing but in relationships, adventure sports, substance abuse, and avoiding COVID. Is there anything you want to change?

I read this aloud on YouTube.

1. My thoughts are those of a career and personal coach. Consider consulting a licensed financial advisor before making investment decisions.