Tuesday, October 13, 2009

Do You Cheat Yourself? Apparently I Do...

CNN-Money recently offered it's readers the opportunity to take a financial risk tolerance test. I am a sucker for personal evaluation tests, so I went ahead and clicked on the link. The test is comprised of 25 questions designed to ascertain how risk averse you are as an investor. Unlike most tests that give you two or three pretty transparent questions and then throw your answers back at you, this test is fairly sophisticated. As I was taking the test I was noticing something very strange about myself: I was cheating. Even though I was the only person who was ever going to know or care about the results, I was trying to game my answers to make sure that the test score came out the way I wanted it to come out.

To be fair, this wasn't a completely premeditated act of deceit. In a couple of places, after I chose one answer, I noticed that this wasn't really a truthful answer. I went back and changed the answers I had first given. In the end, the answers I submitted were sincere, but I am not sure why my initial reactions were not honest. I have been thinking about this for a couple of days and I think I have a good theory. I believe I know myself very well, especially in matters of personal finance. I also think that I understand my tolerance for risk and my behavior under pressure. Here I was, taking a test that was supposed to tell me something about myself that I did not already know. Damn arrogant test. It thinks it knows me better than I do? I'll show it. I'll give the answers that will generate the results as I know them to be.

Not very smart or mature, I admit.

Still, I did catch myself and fix the erroneous answers, so give me small credit please.

The bottom line is that I scored a 68 on that test, with the following description for my risk tolerance:
"Most commonly they think of "risk" as "opportunity". They have a great deal of confidence, if not complete confidence, in their ability to make good financial decisions and usually feel very, or at least somewhat, optimistic about their major financial decisions after they make them.

They are prepared to take a large degree of risk with their financial decisions and are usually, if not always, more concerned about the possible gains than the possible losses.

When faced with a major financial decision you are usually, more concerned about the possible losses."
Actually, that's pretty good. This is very close to the view I have of myself and my tolerance for financial risk. In the end, after trying to cheat the test, I have to admit that it did a pretty good job at what it was designed to do.

A final word on my risk tolerance and our asset allocation. The best measure of your correct asset allocation, in my opinion is this: if you went through the most recent crisis and held onto your asset allocation strategy, you have a good understanding of your tolerance for risk. If you bailed out when things got rough, you are probably taking on more risk than you can handle. Remember that next time the market turns up and you are tempted to jump back into stocks (as in, now, for example). If you want the ups, you have to be able to live with the downs.

So, dear readers, let me know what you think of this test and let me know what your test scores turn out to be. I am also curious to know if anyone else finds themselves cheating on personal assessment tests that only they will ever see the results to. Humans are strange beasts.

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Rob Bennett said...

The best measure of your correct asset allocation, in my opinion is this: if you went through the most recent crisis and held onto your asset allocation strategy, you have a good understanding of your tolerance for risk.

I love hearing your honesty about feeling a desire to cheat on the test. That shows a rare level of self-awareness.

I don't agree with the comment quoted above. If you look at the history of secular bear markets, they always take place in stages. There's never just one fall followed by a recovery. The reason is that it is we humans who are causing the crash (by giving up our earlier confidence in the "idea" that the bull market prices were real). We can only take in so much bad news at one time. So we always elect to let it in in stages. First one crash. Then some movement up. Then another crash.

The next crash will be much harder to take than the last one. Some of us were able to write that one off as a fluke, just some strange event that happened. When the next crash hits, people will have had months or years to think through the loss in life opportunities they have experienced as a result of their failure to sell when they had the chance to do so. They will be feeling bad about stocks even before the crash hits, which was not the case the last time. Then, when prices crash again, the thought that will hit will be -- "What if everything I believed about stocks is wrong? In that case I really should sell, shouldn't I?"

Buy-and-hold works only if you never sell. We tend to think that we are geniuses for being the first people in history to have come up with such a brilliant strategy. The reality is that many who have come before us came up with the same idea and suffered huge losses as a result. The flaw in the idea is that, once large numbers of people come to believe that stocks are always best so long as you never sell, prices are pushed so high that the fall that follows is huge enough to force everyone to sell.

Buy-and-hold works only so long as a large number does not come to believe in it. Just about everyone came to believe in it this time around.


Traciatim said...

I pulled out a 67 on this test, but estimated my results at a 77. I guess I'm not quite as aggressive as I thought I was.

I usually try to be honest on tests like these.

Shadox said...

Traciatim - funny. My guess as to my final result was 65. Pretty close to the actual one. I also thought it was a very interesting question to include in the questionnaire...