How much risk can you handle in your investment portfolio? In a recent Wall Street Journal column, Jason Zweig looked at how to answer that question — and how brain science can offer some clues.
“Because people have a remarkable ability to distort their own memories, investors who panicked in 2008 and 2009 may be kidding themselves about their ability to survive another crisis,” Zweig writes in his piece. And the typical “risk-tolerance quiz” used by financial advisers is almost useless in predicting how you will react to losses, because perceptions of risk vary so widely.”
Zweig notes that scientists have found that the thickness of gray matter in a person’s right posterior parietal cortex seems to correlate with the person’s risk tolerance, and talks about what he learned about himself from participating in a study that examined that relationship.
But he said science can’t yet tell you when market pain will exhaust your patience and make you deviate from your investment strategy. To find that out, he says investors should ask themselves four questions. Among them: Have I turned rules into habits? “It’s human nature to believe, when times are calm, that you will do the right thing in the heat of the moment,” he writes. “But you can be placid in a panic only if you have practiced rules until they have become habits. If you obsessively checked the value of your portfolio earlier this month, you need to ban yourself from looking at your accounts while the market is open. And if you can’t turn that rule into a habit, you probably have too much in stocks for your own good.”