Common Risk Tolerance Blunders
I’m Andy Temte and welcome to the Saturday Morning Muse! Start to your weekend with musings that are designed to support your journey of personal and professional continuous improvement, and to improve financial literacy around the world. Today is April 26, 2025.
We’re going to wrap up our conversation on risk tolerance this week by discussing common risk tolerance blunders humans make on a routine basis. This isn’t the last you’ll hear on the subject as there’s a lot more to discuss on how to measure risk, the relationship between risk and market volatility, and many other topics.
In the following, I’m going to be framing common risk tolerance blunders as those that “investors” make. I put “investors” in quotes because it’s easy to imagine that these blunders only happen when investing in securities markets or other savings vehicles, but that’s not the case. You invest in homes, cars, education, relationships, and your personal well-being, just to name a few non-investment related activities where risk plays a role in your life.
So what are the common blunders that investors make when it comes to risk?
FOMO and the Behavior of Crowds. FOMO, or the fear of missing out, is a dangerous blunder to make. In psychology circles, this is often referred to as the Behavior of Crowds where one abdicates their personal agency in favor of following what everyone else is doing. When you were a child, you probably heard your parents scold you for going along with a group behavior when you knew, or should have known, that doing so was going to be detrimental to you. “I suppose if Toddy jumped off a bridge, you’d do it too!”, screamed a parental figure in frustration of your loss of control. As you invest, it’s important to stick to your plan and not jump on the bandwagon of passing fads that don’t align with your short or long-term goals.
Panic Selling. This is so incredibly easy to do. Let’s suppose the stock market plummeted 20 percent in just a few weeks. News of this market downturn is everywhere. All the financial pundits are screaming at the top of their lungs that the sky is falling and it’s the end of the world as we know it. Intellectually, you understand that your investment portfolio has a very long time horizon and you have both the tolerance and capacity to ride out what will, in all likelihood, be a temporary downturn. Instead, an irrational panic sweeps over you and you decide to sell as the market is falling. Since the market will recover given enough time, you just locked in losses that will assuredly hurt your long-term returns on your portfolio. They say patience is a virtue, but in investing, patience is an important skill to build.
Not Doing Your Homework. Related to FOMO and the Behavior of Crowds, taking advice from others without a full understanding of the risk you’re taking by investing in an asset (or engaging in some other activity) can lead to unexpected, and sometimes catastrophic outcomes. A modern example of this is the current hype surrounding cryptocurrency. You’re at the water cooler talking to your colleagues and someone starts touting the amazing returns they’ve achieved by buying Bitcoin. You decide that you better not miss out on this opportunity without first gaining a working understanding of what Bitcoin is and its risk profile. You buy in and then Bitcoin crashes the next day. Had you done a little digging into the risk and volatility characteristics, you might have avoided unnecessary mental anguish from the wild ups and downs Bitcoin can take, and these ups and downs don’t fit your risk tolerance or capacity. Doing your own homework can help avoid regret and buyer’s remorse.
Not Reassessing Risk Tolerance. As we mentioned in last week’s lesson, age and time horizon are significant factors that affect risk tolerance. It’s easy to move through life blissfully assuming that you’re young and invincible only to wake up on your 50th birthday to realize that you’re no longer young and invincible. At least every 5 years, you should have a conversation with yourself about your tolerance for risk, (re)take a risk tolerance quiz to see if your attitudes toward risk have shifted, and re-evaluate your time horizon and capacity for assuming risk. Has income changed? Have you realized the kind of returns you expected when your financial goals were originally set? None of us lives forever and we must engage in periodic reviews of our goals and our attitudes toward risk.
Cognitive Bias and Overconfidence. We’re not going to dwell on cognitive bias because we dedicated a number of lessons to this concept back in March of this year. I recommend that you go back and review the lessons from March 8 and March 15, because the majority of the biases we introduced can have a profound impact on our consumption and investing behavior, and may lead us to take risks that we don’t intend.
Next week, we’ll turn our attention to the fundamentals of money and the macroeconomy. While this may sound incredibly dull, I’ll be doing my best to keep things approachable and relevant to your journey of building your financial literacy and decision-making skills. Until then…
Grace. Dignity. Compassion.
