Are you Falling for the Great Investing Anomaly?

Are you Falling for the Great Investing Anomaly?

Before making an investment decision, it is critical to understand the key concepts of risk tolerance and risk capacity. Put simply, the former refers to the investor’s emotional or psychological inclination to risk assets for potentially high rewards; the latter is the measure of a portfolio’s mathematical ability to sustain potential market loss in the course of reaching its financial goals.

These two factors don’t always correlate: if the amount of risk necessary to meet growth targets exceeds the investor’s comfort level, a shortfall will occur. On the other hand, if a highly risk-friendly investor takes unnecessary chances on volatile investments, either great rewards or damaging portfolio setbacks will follow.

Optimal Risk

Aggressive or risk-friendly investors are ones who are willing to accept the possibility of financial losses, while conservative or risk-averse ones are more concerned with preservation of the initial capital. Both philosophies have their pluses and drawbacks from an objective stance: when combined with a holistic view of the portfolio’s risk capacity, a picture of “optimal risk,” or the best strategy for a particular investor-asset-timeframe combination, emerges.

The Great Anomaly

Imagine if someone asked you who you were going to support during the next American Civil War. What would your answer be? You would probably say that it’s nonsense. But following the logic of many investors, it’s a legitimate question: it has already happened once and therefore it is bound to happen again. Furthermore, it hasn’t happened in a long time, and therefore it’s likely to happen soon. This is an example of the Great Anomaly: the confusion between certainty and safety. Many investors idolize the “guaranteed” returns of U.S. Treasuries and certificates of deposit, but do not take the erosion of purchasing power into account. Overinvesting in “safe” instruments often translates into very modest returns and the need to reduce living standards.

Understanding Your Risk Tolerance

Intense introspection is the cornerstone to determining your personal risk tolerance. While attaining personal finance goals is important, sometimes it’s necessary to evaluate them in a holistic sense with the help of a professional.

OptiFour Integrated Wealth Management’s team of dedicated financial professionals has provided financial evaluation, financial planning, and implementation in Washington, D.C. for over 25 years. Visit our homepage to learn more about our personalized services.