It’s time in the market that counts

“Fortune favours the brave.” Investing more aggressively is one of the key behaviours of money masters in creating long term wealth. But when the share market falls suddenly and significantly many people cannot contemplate such a behaviour.

To help you be comfortable to invest more aggressively you need to invest time educating yourself about the short term risk, the long term rewards and your available options. Education and awareness is one key.

To assist you, Vanguard have published a chart of the volatility of the Australian share market index over the past 30 years. It shows that there have been 7 times since 1978 that the index has fallen more than 10%, for an average fall of 21.2%. The chart also shows the time length of the downturn and the subsequent recovery.

View the chart on the Vanguard website.

Remember: wealth creation is a long term game. What happens in the short term is mostly irrelevant – it’s just a blip on the radar.

Four Lessons from the Market

Morningstar and IFSA (The Investment and Financial Services Association) have combined to publish an interesting article that helps one keep recent volatile markets in perspective.

It may not be the first time that you have heard of one or more of the lessons but you may find that the current share market volatility has changed your receptiveness to the lessons in the article. So the article is worth reading with a fresh mind, especially if you would like to increase your tolerance of risk to take advantage of a broader range of opportunities.

Read Four Lessons from the Market now.

Volatile markets present a great opportunity

Many media commentators are suggesting that the current volatile Australian sharemarket potentially presents a good opportunity to buy. But I think it actually presents a terrific opportunity to learn.

Most likely it is only people with an existing appetite for risk and confidence in their decisions that would be comfortable buying at volatile times like now.

So for everyone else it is a great opportunity to learn and to begin the journey of increasing your tolerance of risk. Emotions are one of the key drivers of risk tolerance. So right now and during volatile times do the following:

  1. Stop, take time and observe your thoughts and feelings about the current state of the market
  2. Write them down in your journal or diary, if you have one, or even in you investment file. (Date the entry.)
  3. Probe deeper by asking the wonderful question that children master: “Why?” For example, “what makes me feel or think that way?”, “What do I think may happen?” Keep drilling and obtain mastery of your thoughts.
  4. Seek resources that help you learn about the thoughts or fears you identified

The Financial Planning Association of Australia have just released this excellent resource to help you learn about risk: “The trade off – understanding investment risk.”

The graph on page 14 is particularly pertinent to anyone thinking they should be selling now. My question to those people is “if you do choose to sell now, what are the triggers that will make you buy again?” If you are serious about long term wealth creation you need to answer that question. The graph on page 14 shows the significant impact of missing the best month because you hesitated in being in the market.

If you are a long term investor turn off the news when the finance report starts. It’s just distracting noise.

Increase your risk tolerance to accelerate like a tiger

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