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Determining an individual’s tolerance for risk is the most important element to investing. We can all shoot for the moon with our individual picks, but do they fit into our portfolios, given our true risk profiles? An essential question this is oft unasked.
In this respect, I saw an article this week about a financial-advisory firm’s investment in a project — run on the pure-research side by financial luminaries at the Massachusetts Institute of Technology — that really piqued my interest.
The goal of the project seems to be to help investors harness technology to aid in their investment buy/sell decisions, and to help them better understand their investor risk tolerances. And that’s what got me thinking about the importance to each individual investor of determining a proper risk tolerance for his or her portfolio.
I think this corporate/academic effort is a project that bears watching, because it ostensibly combines behavioral research data with quantitative observations about the stock market. I’d love to see something in the results that helps investors make their decisions, giving them more brain-space to ponder issues about more germane topics, like firms, fundamental futures. Nevertheless, I would still warn investors that results from this, or any, automated system can be misleading unless properly interpreted.
Therefore, I could not think of a better reason for investors to use the services of a professional advisor; only candid, one-on-one conversations can really get at how sensitive individuals are to the multiple levels of investing risk. A good advisor can help define that tolerance through a combination of mathematics (about your time-horizon, funds invested, etc.) and personal conversations that will reveal your real tolerance to investment risk.
I get a lot of questions from subscribers asking when they should invest in individual stocks I incorporate into the service I run for the benefit of just one investor (OK it’s a joint familial account, so technically two).
I always resist answering questions like that directly. It would be against the law, of course, but my compass tells me it would be ethically wrong. I do not know the individual risk tolerances of each subscriber, so to advise them I would need a license to do so in their location — and a personal relationship. But what I do is this: I use a proven, long-term oriented system to pick stocks that incorporates measures of risk right alongside those pertaining to return characteristics of stocks. And I make decisions I feel will maximize return for the entire portfolio, given the risk tolerance of the client — a tolerance level that may, or may not, match that of each individual investor.
Still, my service can work well for subscribers, as long as they understand how much risk is warranted for them individually.
When I was researching this topic, I noted a plethora of websites dedicated to helping investors understand their own risk tolerances. If you search “investor risk tolerance,” you’ll see what I mean. I won’t endorse any of these “quiz” sites, or those sponsored by government agencies, as superior to one another. But I would strongly urge any readers here to make sure they know where their position lies on the continuum of investor risk profiles.
All of this research may turn up some good gauges of individual risk tolerance, but I’ll reserve judgment until I see a system that can accurately reflect risk-seeking/averting behavior from the opposite. I think these decisions are clearly less than rational, especially over the short term, so I’ll continue with my approach to the markets for now.
Here’s my current once-over:
As we watch the markets vacillate around all-time highs, driven by earnings reports thus far in the second-quarter earnings season — which have been decent thus far — I think it is time to remind investors not to get too caught up in any bravado concerning the information tsunami we are experiencing, and to make sure to take a pause to consider their individual perceptions of risk. Risk is a topic that I think receives short shrift in the financial news media and in the opinion-o-sphere, which seems tilted toward a focus on the return portion of the investor decision-making process.
By this, I do not mean to undercut the importance of current corporate earnings reports in our mission as investors to achieve superior returns. Earnings reports are extremely important for the data they provide, which in turn fuels analyst forecasts about future fundamentals.
Even more important than the reports themselves is any management guidance about future profit reports. So far, they’ve been pretty good, which has helped buoy the bullish leanings of the current Weiss Ratings set, upon which our decisions are made in the Weiss Million-Dollar Ratings Portfolio. But we need to be cautious, as the market has made a base around a new-high region that seems more emotionally driven than fundamentally so. We need to keep an eye on the big picture, as it has been a main driver of markets in the past few years.
[Editor’s note: For more information on Don Lucek and the portfolio he manages, click here.]
Here’s my view of the big picture right now: Early reporters in the S&P 500 class of equities have by and large beaten expectations at a solid rate (low 70’s percentile area, which indicates some strength versus historical norms), but macro concerns have held back a furtherance of the emotionally driven surge of late in the equity markets.
What I mean is that bullish investors seem to be taking stock not only of these current earnings reports, but attempting to take it all in — incorporating the current macro situation into the micro, more than they have outside moments of fear in the recent past (see summer 2011 for a good example).
There is a risk now present regarding equities, diversion from fair value that may be just temporary, and I think my service needs to remain positioned defensively — a position that has produced returns without too much risk, in my view. We shied away a little from full investment as the market rose, while the Weiss Ratings sank. However, as we crossed the midyear mark, the Ratings seem to have notably bottomed, and are revealing some solid opportunities for the second half of 2014.
OK, here’s the bottom line on all I want to say today: I can use a Ratings system to run a portfolio. It can have demonstrated superior, raw, performance versus alternatives or the market. But the risks taken may not match those you, as an individual investor, may face. Search that term, “investor risk tolerance,” to see what I mean. We can hope that new initiatives will truly help boost investor knowledge and confidence in their decisions, but I’m afraid the human element will remain incalculable.
Best,
Don Lucek
P.S. Dr. Martin Weiss, the man who revolutionized stock ratings in 2001, has now revolutionized stock investing. For a free report on Dr. Weiss’ Ultimate Stock-Picking Tool, click here now!
