Smoking causes cancer, Overeating causes weight gain. You have heard of all of the studies done through the years that seem to come up with the obvious. Now, we have one with investment risk. Researchers at the University of Missouri have come to the conclusion that as you grow older and get closer to retirement your tolerance for risk decreases.
In other words, as you age you want to take less risk with your investments. I would suggest that is pretty obvious. I would conclude through the use of common sense (no study required) that on a percentage basis, people would prefer to take less risk as they get closer to the day that they would need the money. The press release states:
“Each additional year of life represents a shortened time horizon for recouping market losses. In addition, individuals approaching or in retirement may shift focus from asset accumulation to asset preservation. These individuals may become relatively more concerned about potential loss of money when they are closer to retirement or no longer have a steady source of income.”
Maybe that is just incredibly obvious to me and no one else. Then they come to another conclusion. A person’s tolerance for risk also decreases as the economy slows or deteriorates. So, as the economy declines people have less confidence and therefore want to take less risk. Once again, that is something that is fairly obvious.
However, this second conclusion startles and worried the researchers.
“Investors should not let the economic climate affect their risk tolerance. Taking more risk during an economic rise and fewer risk during a downturn amounts to buying high and selling low. That is a very counter-productive strategy.”
This is the problem with the financial services industry. They want investors to believe that you follow a certain set of rules, never deviate from them, and everything will work out just fine. In this case, rules are a substitute for thought.
In a perfect world, yes, you might consider it a counter-productive strategy. However, in the real world where risk is real, I think that it is a very productive strategy. This means that investors are starting to recognize a simple philosophy of investing: They are analyzing and thinking about what they are doing.
If risk levels are becoming higher and higher due to economic conditions, it might be prudent to decrease the amount of risk you are taking where large losses could occur. Of course, it completely depends on your own risk tolerance and life situation. Keep in mind something about the industry. They never want you to sell your investments. They want you to buy and hold.
The reality is that a Plan B or a time where you reduce risk or sell investments can be a lifesaver and not a counter-productive strategy. Successful investing is about a Plan A AND a Plan B!
