The Wealth(y) Solution

When it comes to investing, it turns out that the rich are just like me and you, only with a few more zeros. They too worry about investment losses more than they appreciate gains. They too often let emotion hold sway over their investing decisions.

So says Eric Golberg co-author of a new book called The Wealth Solution and the Director of Wealth Management for Loring Ward, a San Jose, Calif.-based investment manager with more than $7 billion in assets under management that published the book.

Golberg should know. He has spent more than two decades working with people worth a pile, from musicians to athletes and executives.  At Loring Ward he works with advisors around the country helping them figure out how to build diversified portfolios for their clients, which are low cost, low tax, and fit the client’s risk appetite.

Understanding just how much risk an investor can take on before bolting to sell out, is the “art” of giving financial advice. Figuring out the “science”? That’s the easy part. “We’ve solved the investment problem,”  Golberg says quoting an associate. “We’ve not solved the investor problem.”

Figuring Out Our Risk Tolerance

To help investors figure out how much risk they can live with, Loring Ward has designed an investor questionnaire that tries to incorporate the insights into investor behavior that academics have discovered over the past several decades studying the field of Behavioral Finance. Meir Statman, a professor at Santa Clara University and a well-known name in the field, sits on the firm’s advisory board.

Chapter Eight of the book, “Building and Implementing Your Investment Portfolio” focuses risk as one key factor that distinguishes each investor. “All of us are unique. All of us have unique goals and, more importantly,  all of us have some unique values,” he says.  “The theme of the book is, ‘How do I make my money work for my life?’.”

Capacity for Risk Versus Tolerance for Risk

The book breaks the discussion of risk into two parts: an investor’s risk capacity and their risk tolerance.

Risk capacity involves the things which determine how much risk you can afford to or need to take. They include your portfolio goals (are you saving for retirement or education?), your time horizon (equities are not appropriate for any goal under five years, for example), and your income and liquidity requirements (how much will you be withdrawing and when?).

Risk tolerance is basically how much risk you can tolerate without panicking and rushing to sell. Some questions that can help you come to grips with your tolerance for risk:

  • Your general comfort with risk:  In non-financial aspects of life are you a risk taker or a more conservative type?
  • Your feelings about market fluctuations: When you think about the wild swings of 2008 and 2009, do you feel that you never want to live through that again? Or are you ok with that kind of roller coaster for a shot at the best possible returns?
  • Your reaction to market declines in your portfolio’s value: Say you’re worth $1 million. You loose $300,000 in twelve months. Can you confidently say that you would not sell at that point?

In Loring Ward’s own questionnaire, investors are often asked to reflect on their own actual experience. This can result in more accurate answers. One example:

What has been your personal experience with financial market declines? Consider your feelings during the steep market declines that occurred during the Great Recession when the S&P 500 Index lost more than 40% over a six month period from September 1, 2008 through February 28, 2009. How did you (or would you have) reacted during that period.

  • I sold/would have sold all of my stock investments.
  • I sold/would have sold some of my stock investments.
  • I made/would have made no changes to my stock investments.
  • I increased/would have increased my stock investments.

These periods of sharp market movement can feel like riding a  roller coaster, a feeling Golberg and his co-authors tried to capture in this illustration from the book. (Please click on to enlarge.):

Financial Advisors and Risk

It’s not only investors who have to take this kind of hard look in the mirror, Golberg says. All too often, advisors fall in love with their own favorite investment idea too.

Golberg gives an example of and advisor who favors a split that’s 70% stocks, 30% bonds. But what if one of their clients could happily meet their goals with only 30% or 40% in stocks? “What’s the minimum amount of risk to meet their goals?” is the question that should be the focus, he says. “Research shows we feel twice as bad about losing a dollar as we feel good about gaining a dollar. You also magnify that as people get older, because they grow more and more risk averse.”

If risk tolerance only becomes more of an issue over time, clearly it makes sense to pay some attention to it and try to figure out how comfortable we are with risk. Whether we’ve got $100,000,000 to invest or $1,000.

1 thought on “The Wealth(y) Solution

  1. Pingback: Is Your Brain a Barrier to Smart Investing? « Portfolio Investing Blog: Portfolioist

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