What makes for a great investment? The answer seems simple. A great investment is one where the value of the investment rises while you own it. There’s one more factor that needs to be addressed with assessing investments: risk. How much risk can an investor stomach while hoping to receive their expected return?
With inflation rising and economic growth sputtering, smart investing can be one of the only ways to make your money grow effectively. But there’s a damaging pattern we see among self-directed investors. They decide to get serious about their money, open a brokerage account, plunk some money into it, and make a few trades.
Some of those trades work out. Others don’t. But because those investors are completely focused on the classic factor for what makes a great investment – the investment’s return – they watch with horror when they are inevitably wrong about the direction of a few of those trades, and the value of their account plummets.
And almost every one of those investors ends up doing one of two things, completely based on the emotion of watching their account balance gyrate: they either pull their remaining money out of the markets entirely, or they retreat into the “Buy and Ignore” investing strategy, at the mercy of macroeconomic forces beyond their control.
But the other factor that makes for a great investment can make a huge difference in this story, aligning your investments with your tolerance for risk. Factoring in risk tolerance can guide investors when they believe an investment will rise in value, but its historical volatility exceeds their comfort level and risk tolerance.
Put another way, even if an investor has the chance to make incredible money with an investment, is it a good choice if they can’t sleep at night while they own it?
The effect of building an investment portfolio aligned with individual tolerance for risk means that, based on the law of historical probabilities, investors should never lose more than they feel they can afford to lose…and potential gains should be commensurate with personal willingness to take risk.
Now, of course, there is always the possibility of a “black swan event” like Nassim Nicholas Taleb wrote about – the extreme outliers that throw market predictability to the wind.
But even including those events, the markets can give you a 95% probability of any given portfolio falling within a specific band of loss or gain – and if the maximum loss fits within your tolerance for risk, that’s a portfolio that might be a great choice for you.
The tough part is that assessing each investment choice for alignment with risk tolerance has been all but impossible, but science and technology are beginning to bridge that gap.
Ultimately, investors who crack the code of their Risk Fingerprint can take the emotion and conflict out of investing, without retreating from the unique potential that the markets have to help them achieve their financial goals and provide for their family’s future.
And that’s a great investment in and of itself.
(NOTE: A special offer for Financial Bin readers: the first 50 readers who sign up at this special link will get a Backstage Pass to check out Riskalyze before it launches, and align their portfolio with their unique and personal Risk Fingerprint).
Aaron Klein is the CEO of Riskalyze, a technology company that is reinventing the way the world makes risk/reward decisions. To learn more about Riskalyze, visit Riskalyze.com.