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Millionaire Money Habits

May 16th, 2008 at 11:15 am

The Problem with Risk Measurement Calculators

risk measurementRisk measurement calculators can be a fantastic tool. You take a quick survey that makes you reflect on how you would feel or react to certain market conditions, and the risk measurement genie tells you exactly how to invest your money.

But risk measurement calculators are only a great tool, if only they produced realistic results.

The problem with risk tolerance calculators is the output is determined by how you think you would respond to a certain scenario. Turns out that how you think you would act is different than you really do when actually in that situation.

For example, “What would you do if your portfolio dropped 20% in value in a single day? Would you take your money out of the market, invest more, or not do anything?”

You might think that’s an easy question . . . you should invest more while stocks are cheap. That may be the appropriate move, but when the time comes and your money is actually at stake, making the sensible decision is not always easy. You might start thinking, “What if the market drops another 20% after I reinvest?”

When your emotions are involved, it’s an entirely different game. That’s why brokerage firms love it when you use their free stock trading simulator. When you use simulations that provide you with fake money to trade, studies show that people have better investment performance then when they use their actually money. Why? Because when you use the simulator, there is no subconscious emotional interference with your decisions.

Millionaire Money Habit: When using investment risk measurement calculators, use the results to guide your investment decisions, but don’t let them be an end-all-be-all answer to all your investment needs. -RT

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