Which Investing Roller Coaster Are You On?
I love roller coasters. I grew up in northwest Ohio and lived close enough to Cedar Point that I would make it there several times each summer. Every time I went, I knew which roller coasters I wanted to ride, and I also knew which ones to avoid.
Some roller coasters were too rough for me. To this day, I don’t ride the Corkscrew because the last time I did, I got a headache from my head bouncing back and forth in the harness.
Other roller coasters were not thrilling enough for me. Some of the easier ones like Iron Dragon are ho-hum for me.
What could this possibly have to do with investing? In the investing world, you may hear a lot about people trying to match a certain benchmark. For example, a lot of investors like to see how they do compared to the S&P 500 index. Other investors compare themselves to the Dow or NASDAQ.
The truth is that you don’t need to match the S&P to be a successful investor. Please do not misunderstand me, you DO need to be invested in such a way to outpace inflation, but you don’t need to match the S&P necessarily.
The most important number you should know is your risk tolerance. Wait, what? Don’t you mean conservative, moderate or aggressive investor? No, I don’t. I mean that there is a scientific way to measure your personal risk tolerance and it is called standard deviation.
Standard deviation tells you the range of returns that your portfolio could get in any given year. For example, if the way your portfolio is built historically has returned about 10% per year and your standard deviation is 15%. You should expect that for the majority of the time, in any given year you could have a return of -5% to a +25%. (As a quick side note, one standard deviation would account for 66.6% of the time and three standard deviations would account for 98% of the time.)
For some people, this range is acceptable and they are like me at the roller coaster park. They have found their perfect roller coaster and they can ride it as many times as they want.
Others are on a roller coaster that is way too much for them. Their range of returns is so wide that they are not comfortable with it. Still others are riding the kiddie rides and know they could handle the next level of roller coasters and should do so.
In my experience, most investors don’t know what kind of investing roller coaster they are on. Very few know that you can actually calculate a range of returns, and even less know how to measure their own investment portfolio’s range.
You don't need to match the S&P, you need to match YOUR risk number. That is what will help you be successful for the long term. Do you know your personal risk tolerance number? Do you know your portfolio’s risk number? They should be the same. If you don’t know your number or your portfolio’s number, please contact us. We can help you so you can be on the right investment roller coaster for you.
