Risk tolerance: The sales tool

Some investment promoters claim they have all this covered. They ask you a series of questions about your risk tolerance before they sell you their products:

• “If the market declines 25 percent in one year, will you take your money out?”
• “Are you able to keep the long-term in mind when markets

fluctuate or are you more comfortable with investments that do not fluctuate?”
These tests determine your so-called “risk tolerance.” Risk tolerance is your ability to handle volatility. Risk tolerance tests are supposed to match you to compatible investments. Unfortunately, they don’t. Risk tolerance is not a good measure of investment compatibility. At best, it measures a narrow aspect of your personality: your theoretical ability to handle volatility. Even if your broker happens to sell the product that is theoretically right for your risk profile and you buy it, studies show that how people think they will react under adverse market conditions and how they actually react are quite different. In fact, few of us know ourselves well enough to know how we would really react in future unknown situations. The real problem is that risk tolerance tests do not touch the crucial issues: who you are as an investor and how investments interact with your personality. For example, they do not address the issue of the adverse relationships you have with the investment seller and others. In fact, they disguise this issue. These tests lead you to believe that you and the salesperson have the same interest. The tests do not address the issue of overconfidence. Overconfident investors believe they have high risk tolerance when they do not. The tests do not address the issue of people pleasing. People pleasers are often aware that they have low risk tolerance but they buy high risk investments to make their broker or their coworkers happy. In fact, risk tolerance tests do not accurately address any of the issues that will lead you to purchase incompatible investments.
Risk tolerance tests are equally ineffective for average personalities and for extreme personalities such as workaholics, gamblers, and compulsive debtors. Extreme personalities typically have little or no self-knowledge. They will fill out risk profiles identical to those of average investors. Yet once sold an investment product, they will abuse it to a degree unimaginable by the average public. Risk tolerance tests do not pick up money addicts of any kind and lead to no help for these people or those affected by them.
While money addiction is more prevalent in our society than most people realize, the vast majority of investors suffer from less extreme forms of investment incompatibility. The more common symptoms include loss of sleep, irritability, unexplained anger or depression, random resentments, a sense that investing is meaningless, money arguments with a spouse or partner that neither can comprehend, a dim view of retirement possibilities, and a thousand forms of fear.
The major investment fears are that you do not have enough investments now, won’t have enough in the future, or will lose what you already have. Then these fears lead to further fears. If you don’t have enough savings, then how could you have enough money for travel, clothes, restaurants, a new car, a better house, a real life? Or you fear you cannot and will not ever grasp the mathematical complexities of compound interest and probability theory and you cannot trust those who do understand these concepts. Then there is the underlying fear that investing is irrational and no amount of study will help.
The premise of this book is that these feelings and fears are normal and healthy; understanding them and understanding the emotional hooks of different investments will lead to a greater sense of peace and contentment in your life. They don’t sell peace and contentment on Wall Street. You have to find it within yourself first and then look for the investments that enhance it, rather than disturb it.
When you know more about yourself and about the products that are out there, no risk tolerance tests with hidden agendas will sell you incompatible investments anymore. Investing will become an area of great satisfaction in your life.