When meeting with prospective clients I try and get a feeling for how much risk they are willing to take. When I start asking about their risk profile the most common answer I hear is “conservative.” From my very unscientific study it would seem that the overwhelming majority of investors are conservative. But with over 20 years in the finance business I know that the way investors define themselves and the way I define certain terms can be very different. Whenever I get the “I am a conservative investor” line, I start probing a bit more. The dead giveaway that we are defining terms differently is when I have a look at their current investment portfolio and see that all they hold are stocks. In my opinion stocks are by definition aggressive investments, so an all-stock portfolio I define as aggressive.
Financial advisors need to understand a client’s risk makeup. I spend an inordinate amount of time trying to understand a client’s risk profile, because in order to give proper advice I need to be on the same wavelength as the client. Many advisors use questionnaires that ask a myriad of questions to try and pinpoint the time period of an investment, investment knowledge, as well as how one would react in various market scenarios. The problem with these questionnaires is that they only paint a picture based on current trends.
When markets have moved up, investors tend to be more aggressive, and the outcome of the questionnaire points that out. Conversely, when investors lose money in the market, they tend to be a bit shell-shocked and the answers provided show that as well.
Back when I was a struggling new oleh, cleaning toilets to pay the rent, I needed to purchase an airline ticket to fly back to the US. I was a big fan of trading options- an aggressive investment approach- and had some success, so I decided that I would trade options for a short period of time and make enough money to purchase a ticket, and then some. Lo and behold I succeeded, and I was off to the US. Making money was easy. Everything I touched turned to gold. And then I got cocky. I started taking on even more risk, and it didn’t take long before I was once again a struggling oleh cleaning toilets!
My own overconfidence led me to dismiss various risks, and created a sense of stock trading invincibility.
I recently opened an account for a client, who insisted that he was a long-term investor. He kept telling me that this money is not needed for at least 20 years. He was a big believer in Brazil and decided to put all his money in Exchange Traded Funds (ETFs) that track Brazil and Latin America. About three weeks into his investment, he called with a panicked tone. He said he wants to sell out of his investments because they had dropped 6% on average. I reminded him of his insistence three weeks earlier that he was a long-term investor. He said that the drop scared him and he believes that the market is going to crash, and wants only the most conservative investment.
It’s human nature. Many investors have a large appetite for risk when things are going well. When markets aren’t so kind, they are the first to run for the exits. Unfortunately that is the exact opposite of what they should be doing; namely buying low and selling high.
If I sound like a broken record, I say this often because it’s so important: Investors should focus on achieving their goals, not trying to make as much money as possible in the market. Money should be used for specific purposes, not to die with the most amount of money possible. The one who dies with the most money does NOT win!
Take out a pen and paper and prioritize your short and long-term goals and needs. Then create a portfolio that will enable you to achieve what is truly important to you. Working with a financial advisor is always useful in trying to clarify what that list includes.
The information contained in this article reflects the opinion of the author and not necessarily the opinion of Portfolio Resources Group, Inc. or its affiliates.