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Can you sleep at night…?

by on August 24, 2010

I wanted this to be a quick post on “risk” – a word that undoubtedly has been thrown around a lot in the investment world but somehow still has no tangible meaning associated with it. Why is risk so important? Risk is essentially *the* determinant of what your investment portfolio should look like: the level of risk you are willing to take on determines the return on your investments. The relationship between risk and return can be summed up in 5 words: higher risk implies higher returns.

This post has been somewhat been inspired by Vanguard’s article on “the truth about risk” – unfortunately, like most finance articles, it’s pretty technical and most of the important points are lost in all the jargon. I also came across myrisktolerance.com, where you can spend $30 in order to “know your financial self better.” I haven’t tried this but if any of you have – it’d be great if you could let us know as to what you thought about it.

So, I wanted to talk about risk tolerance means to me without getting technical – simply put, it’s the sinking feeling I get at the bottom of my stomach when I lose a certain amount of money (Vegas, anybody?). If you think about it that way – it’s really not that complicated. For a second, forget about the “risk of a downturn in stock prices and inflation eroding an asset’s buying power…” and think about when it is that you cash out. How much do you have to lose before you break out into a cold sweat or just get plain ol’ sad?

Now think of that number – the amount of money you’re willing to lose and add a buffer of say 20% to it. Suppose that number comes out to being 15% – if you’ve invested $1,000 in a portfolio, then at any point of time you would ideally like the value of the portfolio to stay between $1,000 +/- 15%, i.e. between $850 and $1,150.  This is precisely your risk tolerance.

Now this can come off as being very unscientific especially since gambling is a one-night occurrence while your investments are supposed to last you for the rest of your life (hopefully!). But at the end of the day losing money has the same impact, whether it be in a dingy casino or sitting in front of you computer looking at your brokerage account with all the numbers in red – it really really blows.

The reason I’ve dedicated an entire post to “risk” (and maybe more in the future) is because really you can’t and shouldn’t even think about starting to invest if you have no idea as to your own risk tolerance. Risk questionnaires are great at telling you what the masses are doing but you are unique and you need to find out what it is that makes you unique. Determine your own risk! (btw, I am in no way encouraging you to take a weekend off to go to Vegas to determine your risk.. no, seriously.!)

Our goal at Accevia has always been to help our users see all their options before making an investment decision but after speaking to some of our test users, we realized that the first roadblock we’re facing is that people can’t make sense of any of the options if they have no idea as to what their risk tolerance is. Hence, this post.

Also, we’ve formally decided to embark on a quest to put together “The noob’s guide to investing” – more on that to come! Contact us if you’re interested in being one of our “noobs” 🙂

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From → Personal Finance

2 Comments
  1. Leyan permalink

    What would being one of your noobs entail? Does this mean being a guinea pig for testing risky investment strategies?

    Very nice blog and site. I requested an invite for the private alpha. Found your site from your comment on Plantly, from an article on lifehacker. I’m a physics grad student at Stanford and have always had an interest in investing and finance.

  2. Our definition of noob is anyone with limited experience when it comes to investing. Their main goals include learning more about what it means to invest in long-term strategies – definitely nothing to do with testing risky investment strategies! We’re not running a hedge fund for the average Joe here!

    Please email me at smita@accevia.com to get an invite code – I’m also at Stanford and I’d definitely love to hear more about our opinion and interest in investing and finance.

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