No one ever lost money just because the market went down.
Generally, the market will do that several times a week.
Rather, people lose money when the market goes down and the level of loss exceeds their emotional comfort level. Fear of suffering additional losses may subsequently have them sell their investment at a much lower price than they paid for that investment.
In doing so, they lock-in their loss, creating a gap in their net worth - a chunk that could be missing for a long time to come.
Because markets have historically moved in cycles, meaning that when they go down, they will generally cycle back up, if you can remain with your investment in tough times, as the market cycles back up, you may benefit and find your portfolio and net worth higher than when the down cycle began.
Just as you should never drive an unfamiliar mountain road without knowing the speed limit to help navigate the dangerous curves along the way, in our view, you should never invest without knowing your risk number.
The theory behind a risk number lies with the understanding that there is a relationship between risk and return. Generally, the more risk you take, the higher return you may receive. However, risk does not guarantee a higher return. When the market is in disarray and we plunge into a bear market, many investors have a “panic point”.
This is the point where the loss they are experiencing in their account creates a severe emotional discomfort that leads to what we term as Emotional Market Timing. This is where emotionally, an investor cannot take any further loss and they sell out of their investment. This is despite the fact that the price they are selling their investment could be substantially lower than what they paid for it. This leads to locking in the loss.
A risk number crystallizes how much loss an investor is comfortable to take before their panic point, which is why we believe having this number is critical. You arrive at the risk number by answering 10 questions and a mathematical algorithm will determine your risk number.
A risk number avoids vague, obtuse, and at times trivial terms like an investor being a “moderate conservative” which we believe does not give a clear view of the amount of risk an investor is willing to take. Once you have your risk number, a financial advisor can build an investment portfolio consistent with the amount of risk you are willing to take.
A risk number does not help you avoid losses in your portfolio, as markets will always go up and go down. Instead, it will help you quantify, in extreme conditions, the amount of loss you can withstand to avoid Emotional Market Timing and locking in losses.
The Independent Financial Advisors who offer Dunham investments can provide you with your risk number. Equally as important, they can also determine the risk number of your current investment portfolio to be certain that they match so you can avoid the potential of Emotional Market Timing.Subscribe to the Dunham Blog