“Dozens of people were injured Sunday, some seriously, when a Hawaiian Airlines flight from Phoenix to Honolulu hit “severe turbulence” about a half-hour from landing.”- Washington Post
Turbulence is common on commercial flights. Severe, unexpected turbulence is “relatively uncommon.” Nevertheless, just reading the above sent your brain to your next scheduled flight or a prior occasion where you experienced notable turbulence. It may even make you nervous about booking a future flight.
Flying commercial is one of the safest forms of travel but headlines like this can affect how we perceive the risk of flying. When this gap between our perception of risk and our risk tolerance grows it can cause us to take actions out of fear (or greed).
This is especially true when it comes to investing. We are in a period now of market turbulence. This is why we should always build plans and portfolios that align with our risk tolerance.* The problem is that real life intervenes. At the start of 2022, not may people were planning for double-digit losses in the broad stock and bond indices. But here we are.
In this post, Sarah Newcomb in Morningstar carefully draws the distinction between risk tolerance and risk perception and talks about some ways we investors can cope with challenging times. Being able to put some distance between our emotions and our actions and reframing information can all help. The bottom line is that a plan that is abandoned at the first sign of trouble is in reality no plan at all. Newcomb writes:
“However, long-term investment plans are only useful if we can abide by them. The fact that our day-to-day perceptions of risk are so malleable and easily affected by things that are not related to the fundamental value of our investment holdings means that we need to be watchful of our own emotional and psychological state if we want to stay the course. There are times when plans do need to be altered, but not every instinct to change course should be heeded.”
Not only do we need to properly align our risk tolerance with our portfolios. We should also build in some room for error. Even deliberately building sub-optimal portfolios that are easier to stick with makes sense. Consistency of behavior is, in part, about not putting ourselves in situations where we can feel off-kilter and off-plan.
Plans do need to change over time. The worst time to do this is during periods of stress, think FOMO or a bear market. Here’s hoping your risk tolerance and risk perception are roughly aligned after a tough year in the markets.
*Although there may be some things you can do to help boost your risk tolerance.
