How fast do you drive? A frame for understanding risk tolerance in investing
by David Jester, CSRIC
When I turned 16, my father took me on a drive. We headed into Burlington, NC where a body shop was advertising a 1983 Jeep Grand Wagoneer for sale. I can still picture it: bright red, a thin chrome line gliding down the center, perched on the once-bustling industrial strand—ready for adventure.
Needless to say, I was in love. It was a good thing, too. Little did I know what that truck (later named Clifford) had in store. Whether we were piling in friends, or recruiting the help of a CJ-7 with a winch to pull us out of an ice-hole on a 4-wheeling adventure gone awry—Clifford was there for me, keeping us all safe with its 4.5 tons of steel, rarely capable of topping out above 75 without a lot of fuss.
Clifford was made for my driving habits. As an experimental 16-year-old, I pushed it, but I always felt safe. With Clifford by my side, I knew that I would reach my destination in one piece. My parents, obviously, were comforted by this too. I’ve only recently come to fully admire their wisdom as my own children are rounding the bend toward their own driving lives. In the world of investing, Clifford would be a very safe play for someone who is risk averse. I tried to drive as fast as I could, but there’s only so fast you can go in a school bus with slightly better seat belts.
Flash forward to a year ago—I was on my way to meet friends for a hike. On the highway two cars in a big rush zoomed past me, weaving in and out of traffic. Unlike Clifford, these cars were made to go fast and handled their risky maneuvers with great agility—and luckily, without fail. At this moment, I had a bit of an epiphany. Our team talks a lot about risk tolerance with our clients. We want to determine how much risk they can tolerate in their portfolios—and we balance that with their financial goals. We consider many factors, from personal to market-based, to arrive at just the right mix. We talk about how taking on risk can increase the potential for more reward. When we take on more risk, we stand to gain (or lose) more.
As I watched these speed racers fly past me, I looked at the safer drivers left in their wake. These drivers would also reach their destinations—albeit slower. However, they were taking on much less risk due to their driving habits. If the speeders got there, it may be a few minutes faster—and who knows, that could yield some great outcomes—but was it worth it?
When I reached my friends, their two cars (a Prius and a Subaru wagon) were waiting for me in the parking lot. I thought about how these choices reflected what I knew about them and I was curious about whether this also indicated something about their investment styles. Turns out, it did. Both were relatively risk-averse investors with a penchant for ESG investing. [ESG investing is when individuals use socially conscious decisions in making investments.] They both preferred consistent and steady returns to volatile swings and were in it for the long haul. They liked safe cars with decent mileage. They were only speed racers in an emergency.
Thinking back to slow, steady, and safe Clifford… while I may’ve wished for speed then, I was sure grateful for safe passage to the here and now.
So, what do you drive?
David Jester, CSRIC is a financial advisor with the Jester Group at Baird. He can be reached for questions or comments at firstname.lastname@example.org. Find more details including his bio at JesterGroupBaird.com