“It’s easy to see, hard to foresee.” ~ Ben Franklin
How often have you accurately predicted your reaction to emotion-provoking events in your life?
When the stock market gets volatile as it has been in recent weeks, I am reminded of the irrelevence of risk tolerance questionnaires. If you’ve ever sat down with an investment advisor or financial planner, you’ve likely seen or heard the questions that try to predict how you might react in various stock market scenarios.
For example:
“If your investment portfolio were to fall by 20% in the course of one year, how would you react? Would you A) Do nothing, B) Wait a few months to make a decision, or C) Sell your stocks immediately?”
After answering about 20 questions like this, the advisor or planner then assesses your risk tolerance and will likely label you as one of three investor types–aggressive, moderate or conservative.
“A man’s knowledge is like an expanding sphere, the surface corresponding to the boundary between the known and the unknown. As the sphere grows, so does its surface; the more a man learns, the more he realizes he doesn’t know. Hence, the most ignorant man thinks he knows it all.” ~ L. Sprague de Camp
The problem I have with these questionnaires is that no human being can consistently or accurately predict their own behavior, especially if they’ve never experienced the scenarios given on the questionnaire. I have several clients who had once thought they were “aggressive” investors–able to tolerate high risk, high volatility–but were ready to bail out of stocks immediately after a 5 or 10% decline. This is not poor judgment on their part–it is simply human.
Consider life scenarios. If your spouse died, how would you react? If you lost an arm, what would you do? If you survived a terrible car crash, what emotions would you be feeling just moments after it occured? The honest answer is “I don’t know.”
“Fantasy may call the grapes of reality sour, but those who have tasted them know at last a dependable delight.” ~ Dorothea Brande
Predicting behavior is at the root of most failure. For example, something that seems difficult to endure is often not as terrible as you might imagine; but because you hesitate or fail to make an attempt at accomplishing a goal, you fail. Conversely, you may imagine something causing extreme happiness so you pursue it. However, if and when the thing is obtained, the happiness fades quickly or doesn’t happen as you had once imagined.
Humans underestimate their ability to endure difficult times and they overestimate the happiness they will feel. Therefore the seemingly difficult goals might never be attempted and the pursuit of happiness can be misleading. The most accurate prediction, with regard to your future behavior, is that your prediction won’t be accurate. Embrace transcience; be content with the way things are now; be satisfied with not knowing the future or attempting to control it; and allow your imagination to be your friend, not your enemy.