My last article was the first in a series on accelerated wealth creation and introduced some ways to identify lazy wealth creation. Many of the ways to crack the whip over lazy wealth creation require a high tolerance of risk. Or to put it another way, you need to be more of a tiger than a pussycat. Today’s article shares some ways for you to increase your tolerance of risk.
Research of tens of thousands of Australians reveals that less than 7 percent have a high or “Aggressive” tolerance of risk.
Therefore, technically speaking this current article series on accelerated wealth creation is only appropriate for about 7 percent of you. But I’m writing it because one of my goals is to help you reap the rewards of increasing your tolerance of risk.
What is Risk Tolerance?
Risk Tolerance is a psychological measure of your willingness to accept uncertainty in your decisions; to handle volatility and the chance of loss.
To help in your understanding here are the definitions of a couple of other related terms that you may have heard.
Risk Capacity is your ability to absorb some downside, both in size of the loss and time available to recover.
Risk Profile is a combination of the above two placed in the context of the goal you are trying to achieve, such as the purpose (end use) and the time before the end use arrives.
Investment products also have a risk profile which is a description of the variability of the rewards from that investment over certain time frames. The investment risk profile is different to your personal risk profile. The process of choosing appropriate strategies and products for your needs includes matching your risk profile to that of the product or strategy.
Assessing your Risk Tolerance
Many of you may have seen the brief multiple choice questionnaires that are included in the Product Disclosure Statements (PDS) of superannuation and other investment products. They supposedly help you assess your risk profile but they are badly flawed as a scientific tool.
They are flawed for a number of reasons: too few questions (20-25 are needed), they are inconsistent and inaccurate, and the questions do not measure what they suggest they are measuring. Warning! Don’t rely on such questionnaires as the basis for your investment decision.
I have only seen three risk tolerance questionnaires that have been rigorously constructed by experts in psychological assessment. The most widely tested one of these is the FinaMetrica questionnaire, which is the one I use with my clients.
FinaMetrica also have a public website where you can assess you tolerance of risk and I recommend that you all complete the questionnaire. Visit http://www.myrisktolerance.com
Increasing your Risk Tolerance
Since risk tolerance is a psychological measure increasing your tolerance of risk involves working on the way you think.
You can work on the way you think by:
- Examining the information on which your beliefs are based
- Examining the decisions you make based on your beliefs
- Educating yourself so that you can make more informed decisions
For example, if you are concerned about a particular event occurring, ask yourself:
- On what facts do I base the belief that the event could even occur?
- What is the actual consequence if the event did occur?
A detailed example of working on the way you think
I’ve observed that many people state they are concerned about losing money (the event) and therefore they decide not to invest. When I dig deeper they are generally concerned about total loss of the invested amount.
The facts are that most mainstream investments are highly unlikely to suffer total loss. Plus, the longer the timeframe until you need to use the money to fund your lifestyle, the lower the likelihood you will suffer any loss.
Next you challenge yourself by asking “if my investment does decrease in value one year, so what?” What is the real consequence of it if you don’t plan to use the money for many years?
Then challenge yourself by asking “what are the consequences of not acting or of acting differently?”
If you haven’t yet acquired enough knowledge to make an informed analysis of the consequences and likelihood of the consequences then seek expert assistance in making the decision.
A Final Observation on Risk
Interestingly, in my experience many people are investing using high risk strategies and products without even knowing the risk they are taking. Not understanding what you are doing is the highest risk of them all. For example, many people borrow money to invest in residential property and tell me it is safe. Let me assure you that the facts suggest otherwise.
Just because the risk profile of your investments is high risk doesn’t mean you have a high tolerance of risk or a high risk capacity. Your world could come crumbling down more than you ever imagined if you don’t understand the risks and the consequences if the risk eventuates.
The best investment we can all make is in increasing our knowledge. We can do this both through education and experience.
So today I encourage you to:
- Assess your tolerance of risk
- Identify and challenge your existing beliefs about wealth creation
- Continue your education
- Forward this article to your loved ones to help them with their education