Did you ever get a speeding ticket? Do you remember what you were thinking right before that moment? Then, when the police lights came on (or the traffic cam flashed) – Frustration! Anger! Regret! Now, how careful were you with your speed after that ticket? Probably a lot more. This is risk perception. The risk of speeding was always there, but you were either reminded or educated about it with a speeding ticket or hopefully a warning.
Your reaction might be the same when it comes to your investments. After a massive drop in the stock market for two days recently, you may have seen your retirement or brokerage account amassing losses equaling your annual income or even worse. How did you react? How did this happen? Should I be concerned? I can’t afford this kind of loss! Or did you brush it off, knowing this is part of investing? Everyone, including the most experienced investor, has an emotional response to sudden drops in the market. To some extent, we all want control over what we manage.
Risk perception is different with investing because you define your speed limit based on your situation and goal. Along with your risk tolerance (your comfort with risk) and risk capacity (how much risk you can afford), understanding this provides a current pulse of your attitude toward risk. You may be someone who wants to drive 75 in a 65 or you may only want to drive 35 when the speed limit is 45.
A example of someone going “35 in a 45” can be found in the financial behavior of both younger and older individuals who were impacted by negative financial events. Children of the Great Depression remember back to a time when they saved as much as they could, not knowing where their next meal or job would be. Many millennials don’t trust the stock market after witnessing their parents getting laid off or seeing their savings wiped out through the Great Recession. These memories have a lasting impact on how they spend and invest. However, it could mean they are not taking enough risk. Younger investors have many years until retirement and should be able to withstand the dips in the market unlike their parents. Older investors with substantial assets can spend more with little risk of running out of money. Some women call this fear the “bag lady syndrome.”
There are tools on the web to help understand whether you’re taking too little or too much risk with your investments. Further, there are now services, called “robo-advisors” that put together and manage your investments on your behalf. However, there is still a major technological gap in the ability for technology to demonstrate empathy. These tools can help an advisor more efficiently deliver their services, but they can’t replace the human experience to understand. If you’d like to discuss your situation to understand more about your risk perception, tolerance and capacity, you can contact a real live person – me!
