For those of you may not know already, I appear on a radio show with Gina Robison-Billups from MIBN.org and Kathleen Bellucci of Pension Solutions every Friday morning. Lately we have been talking about how the listeners should approach their 401(k) plans.
Today's show will pose the following question (which you can hear here if you like) or simply read my answer below.
The question: How does someone choose the funds that suit their needs…risk tolerance???
Good question and something I have discussed at length on the website, in articles I have posted and commented on and at length in all of my books. In fact, I devote an entire chapter of my next book on the topic.
And still, after all of the academic papers, research, books and such, we still can’t pinpoint what risk is. We know that we try and figure out how much we can tolerate, hence risk tolerance. What we don’t understand is why it changes over time, with cultural shifts and economic upturns and downturns. If you knew how much risk you could handle – and get a good night’s sleep in the process – why would it change?
I’m thinking that a better term for it would be anxiety tolerance. We all know what makes us anxious. According to Robin Marantz Henig, writing for the New York Times magazine, “anxiety is not fear, exactly, because fear is focused on something right in front of you, a real and objective danger.” Investing is dangerous but not a danger. Ms. Henig suggests being anxious is “fear gone wild”.
This she says happens when we are confronted with novelty and threat. For many of us, this past year is unlike anything we have ever experienced and certainly threatened our investments and our retirements.
So how do we cope with anxiety tolerance or find out what ours is? I’ve given it a lot of thought and figured out that most of us are anxious about some decision or another. Investing is no different. Even savvy investors worry. Vanguard recently published their own worries suggesting that Investors not get too giddy with the recent market upswing.
My suggestion to you if you are feeling anxious: You should invest consistently, good times or bad, up market or down. If you have a broad selection of funds and you are feeling anxious, keep investing but for the time being, use a total market index fund. At least you will be capturing something.
So risk is hard to define. But what makes you anxious is not. Using the index fund when you are feeling worrisome will also lower you risk at the same time.