Our Perceived Risk Tolerance Levels Have Drifted Out Of Whack No ratings yet.

It’s been over 10 years since the market delivered a striking blow to our portfolios and our investor psyche. We’ve likely all forgotten what it feels like to watch our portfolios lose 30%, 40% or 50% or more of the value. Quite frankly, we likely do not know what is our true tolerance for risk.

If you’re a “newish” investor and you have not experienced a major market correction, you do not know your tolerance for risk. You’ve never felt it. And it’s a feeling alright. You’d have to ask yourself, what does it feel like to watch your portfolio “lose” 30%, 40%, 50%, 60% of its value? If you have not felt it, you don’t know it.

Even for those of us who have invested through major market corrections, we have not felt that true angst in quite some time. We have forgotten what it feels like. And that risk tolerance drift has likely increased the likelihood of bad investor behaviour in the next major market correction.

From January of 2009 to end of August 2019, here’s an investment in the iShares Core S&P 500 ETF (IVV). The chart is courtesy of PortfolioVisualizer.com.

A $10,000 investment would have been turned into over $40,000, and with very little volatility. With dividend reinvestment, we have not even seen a correction of 20% in the last 10 years.

But here’s the chart we should be looking at. We’ve also forgotten what it feels like to have our portfolio decline for 3 years running, i.e., 2000-2002. Of course, that is the decline history for the US market. Canadian and international markets did not experience that three-peat.

While this chart represents annual increases and declines, keep in mind that the US stock markets fell by that 50% range in 2008-2009 and in that correction in the early 2000s.

And again, that’s why US investors might consider this article “This Table Suggests US Investors Might Be Well-Served By International Stock Funds.”

With the recent runaway success and out performance of US markets, there’s some additional recency bias that we might forget. An American investor would have experienced better total returns and risk-adjusted returns over the longer term with a portfolio that included some international diversification.

Maybe US stocks will not continue to outperform in the next decade or two just because they outperformed in the last decade. Maybe they’ll go into the tank and we’ll experience another lost decade for US stocks. Who knows?

A 20% correction and a 50% correction are two different animals.

Here’s the Canadian market represented by the iShares Core S&P/TSX Capped Composite Index ETF (XIC).

There was a correction into early 2016 that approached 20%, and again, we saw a modest but official correction at the end of 2018. For experienced investors, those modest corrections should not feel like much at all.

Here’s what a real correction looks like when we include 2008 and beyond.

We see the obvious escalation in overall decline in portfolio value and also in the severity of the quick and steep decline. It’s “going” straight down for a few weeks and months. I’d suggest that the 50% decline does not feel twice as bad as a 20% or 25% decline, but that it feels 10 times as bad. The news and commentary are catastrophic. In 2008, there was talk of the financial world not functioning, period. The whole capitalist way was going to blow up. The headlines get 10 times as scary. The real and personal financial tragedies are perhaps 10 times as bad. I experienced that. I lost my job in 2009, as I was working almost exclusively on a US bank client – ING Direct US.

Modest corrections should be “easy”.

In 2016, I wrote the article “Bring On Those Lower Prices, Says The Dividend Income Investor In Me“.

Yes, some bravado and stock buying chest thumping. And there was no exaggeration. I remember the period and the feeling quite well. I truly enjoyed getting those lower prices and those bigger dividends. And those bigger dividends have certainly helped in my new life work stage. I left my full-time job and moved to working on my site and some freelance writing, which includes Seeking Alpha.

In that article I wrote:

I took advantage of other wonderful reinvestment opportunities in the Canadian bear market picking up shares of BNS on January 16th, 2016 at $51.47 per share. On Feb 12th, 2016 I was able to purchase more of (NYSE:RY) at $66.87 a share. On Feb 3, 2016 I was able to purchase (NYSE:TD) at 52.86 May 16, 2016 (NYSE:TRP) $50.99. On June 6, 2016 I was able to purchase Telus (NYSE:TU) at $41.07 per share.

It was not difficult to invest new monies and portfolio income when my portfolio (that includes some bonds) is only retracing by less than 10%. My Canadian Wide Moat 7 also performed better than the market with respect to drawdown. Here’s the 7 big Canadian dividend payers as Portfolio 1.

And, of course, throw in some US assets in the mix and the overall portfolio drawdown is not much to stomach at all, even though the Canadian assets were declining in what they’d call true “Bear Market Territory”. Some individual stocks fell much more than the market indices – all the better.

It was easy to execute. I did demonstrate good behaviour in a minor correction, but what about in the next big one?

I’ve let my portfolio risk level drift as well.

I think the two events go hand in hand. If our perceived tolerance for risk increases, we’re naturally going to let the portfolio risk level increase. But what if that creates a mismatch?

After the major correction into 2009, I began a process of de-risking as the assets recovered. I eventually moved to an area of 65% bonds and 35% stocks. I had the bond exposure that I wanted, and then I executed an equity glide path, with all new contributions and portfolio income being exclusively invested into stocks and equity ETFs. That strategy can also be put to work by retirees.

The generous returns in US and Canadian stocks has turned the tables, and the portfolios sit in the area of a Balanced Growth Model – that sweet spot. But does a Balanced Growth model match my risk tolerance level? Or perhaps, I just feel that a real major stock market correction is not in the works?

I can feel that I’m cheating myself on risk tolerance. I’ve forgotten what it feels like. I can go back and read my previous articles to get more than a glimpse of what it felt like to invest through a recession. Today, to be honest, I’m not feeling it.

And yes, these minor corrections give us “a taste”. On Seeking Alpha, Mike Tyson made an appearance in “Mr. Volatility Is Asking You, Taunting You – So You Wanna Go?” And in 2014 I asked, in the next correction, “will you be a winner or a loser?

Time for some honest reflection.

What about you? Do you feel that your risk tolerance level has drifted? Did your portfolio drift? And if you’ve never been through a major correction, it might be time to count your lucky stars and do that personal risk evaluation as best you can. Here’s an article that might be some help in that regard.

Author’s Note: Thanks for reading. Please always know and invest within your risk tolerance level. Always know all tax implications and consequences. If you liked this article, please hit that “Like” button. Hit “Follow” to receive notices of future articles.

Happy Investing.


Disclosure: I am/we are long BNS, TD, RY, AAPL, BCE, TU, ENB, TRP, CVS, WBA, MSFT, MMM, CL, JNJ, QCOM, MDT, BRK.B, ABT, BLK, WMT, UTX, PEP, TXN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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