Risk tolerance is a funny thing. Most people think they have a higher risk tolerance than they really do. But the reality is, only when you are losing a lot of money do you finally realize what your risk tolerance truly is.
I’d like to think that I’d be able to stay the course and go all-in during a stock market downturn like everybody I meet on the internet, but I’d be lying to myself.
With emotions and people depending on you to survive, your risk tolerance likely isn’t as high as you think it is. Just like how your net worth is an illusion, so is your risk tolerance.
Experiencing rapid losses in 2000 as a 23-year-old freaked me out. Therefore, I sold all my after-tax internet and tech stocks within two months after the downturn began because I was losing roughly $5,000 a week.
In the end, I lost about 10% from the peak. If I hadn’t sold, I would have lost around 65% over a two year time period. What’s worse, I would have had to wait until Aug 1, 2013 to get back to even! Can you imagine sitting on dead money for 13 years?
Between 2000 – 2013 I continued to max out my 401(k) and buy stocks. But I didn’t have the foresight to go all-in on August 1, 2002 when the NASDAQ bottomed. Instead, I mostly hoarded cash and bought 4.5% yielding CDs as I moved from NYC to San Francisco in 2001. The last people to join a company tend to be the first to let go.
Seeing how violently stocks corrected between 2000 – 2002 made me gun shy to ever bet the farm again. Instead, I bought San Francisco property in 2003, 2005, 2007 (Tahoe, oops), and 2014 because it felt so much better to have a physical asset instead of a paper asset.
After the financial crisis of 2008 – 2009, I again didn’t step up to the plate and buy large amounts of stock or property between 2008 – 2011. All I did was continue to max out my 401(k) and make sure I didn’t get laid off. I became disillusioned with the financial services industry and wanted out. Therefore, I ended up hoarding more cash to give me options just in case I decided to take a leap of faith, which I did.
It wasn’t until August, 2012 that I bought 12X more stock than my normal cadence due to a severance windfall. I viewed my severance as the house’s money, so I figured why not risk it all and see if I could make more in the future. With my non-severance cash flow, I remained conservative.
Despite feeling like we were out of the woods by 2014, I still couldn’t invest aggressively in the stock market. I was again fearful of losing money.
Instead, I decided to buy a SF fixer in 2014 because it felt like there was some serious mispricing of SF ocean view property. But the other reason why I bought was because I wanted to reduce my housing expense by renting out my old place.
After selling a SF rental home in the summer of 2017 in order to simplify life, I decided to invest ~$1.2M of the ~$1.8M net proceeds in stocks and bonds. I had already taken risk exposure down by $800,000 by getting rid of the mortgage.
I told myself that my risk tolerance was being able to lose about 10% before worrying, so I invested in roughly 60% stocks / 40% municipal bonds.
Everything had been going pretty well since August 2017 when I first opened up the account. Then February and March 2018 beat me up.