In our most recent entry on this blog, we discussed an article that recommended that investors avoid developing an emotional attachment to companies whose products or services they use regularly. And while taking this approach can help you better respond during periods of volatility or elevated risk, this doesn't mean that you should neglect your emotions altogether when making decisions that affect your portfolio.
On April 19, The Wall Street Journal published a report that aims to help investors get in touch with their feelings when making key decisions regarding their equities and highlighted the benefits of this approach.
"Deeply buried fears can keep us from taking risk – keeping us safe, perhaps, but also robbing us of potential return," the report noted. "A strong tendency to regret past choices can keep us from repeating blunders, but also from repeating sound strategies that simply didn't work out the first time."
To help investors take a step back and evaluate their feelings regarding their investment choices, the Journal prepared a quiz for its readers. The first question asks you to consider the risk and reward balance in your portfolio in a scenario where you have a 50-50 chance to increase your standard of living by 50 percent in your lifetime.
However, the catch is the portfolio could also reduce by an unknown percent, identified in the article as X percent, and the intent of the query is to get you to provide a number between 5 percent and 50 percent that you're comfortable accepting X percent to be.
What's your number?
Still unsure? The Journal indicated that most Americans will accept a maximum risk of 12.5 percent, which means they believe pain is four times as important as potential gain.
"Breaking that average down further, men are more willing to tolerate risk than women, and the young are more willing to tolerate risk than the old," the report says.
But, just because you've determined your number, that doesn't mean this exercise is over. After all, if your acceptable risk figure is low, you may be impeding yourself from making decisions that allow you to meet or exceed your goals.
You may find that you simply just don't want to take on that much risk. In this case, the source advises that you consider making stocks a larger part of your portfolio to make up for what it calls your "cautious tendencies." It also suggests that aggressive investors think about the potential advantages of bonds or conservative investments that could help protect their portfolio from risk.
At SmartStops, we'd like you to know that you don't have to make these decisions on your own. After all, you need to evaluate more than just your total loss tolerance when investing. That's why we provide free tools like our Risk Based Position Sizing Calculator.
This tool allows you to input the stock symbol of the equity you're considering as well as the dollar amount that you wish to allocate to this holding. Like this exercise from the Journal, our calculator will also ask you what you're willing to lose on this investment.
And since you've completed the exercise, all you have to do is use the percent you selected to determine how much of your upfront costs you're comfortable risking.
Once your short-term SmartStops and long-term SmartStops are set, you'll receive emails when elevated risk levels are detected in your stock or ETF. At this time, you can make a timely decision to sell, hedge or take another protective action.
Categories: Risk Management, Trading & Portfolio Strategies