As investors, a lot of our choices have to be thought out clearly and systematically. Arbitrary or capricious decisions can cost us big time. Before any investment decisions are made, we must weigh our possible options. Do we buy bonds? Large-cap stocks? ETFs? For how long do we hold our investments? At what point do we double down or sell? These questions, along with many others, can only be answered after we truly understand our personal investment styles.
While “getting to know ourselves” might seem like a simple concept, seriously considering (and even writing out) our personal preferences, numerical goals, and individual time frames can facilitate our decision making and aid us in reaching our ultimate goals. Plus, the act of writing down these personal answers can help us remember and stick with our hard-and-fast goals in the long run. Investors, grab a pen and paper because here are seven essential questions you should address to help you better understand yourself as an investor:
1. How old are you?
(Translation: how close are you to retiring?) It’s no secret that many of our money-saving and investing habits are driven by our age as well as the age we would like to retire. A person in his or her twenties may have more difficulty saving money than a person in his or her fifties due to job novelty, rent or mortgages, and student loans, among other things. On the other hand, an investor in his or her twenties may be more inclined to take a higher level of investment risk than an investor who plans on retiring in the next few years because he has more time to make back any lost money. Essentially, the way you answer this question can say a great deal about your risk tolerance.
Long story short: Write down the difference between your ideal retirement age and your current age. You might consider reducing investment risk as that number gets smaller.
2. When did you start investing?
This question is all about experience. How long has it been since you first created your investment portfolio? Are you confident that you can pick stocks that would yield higher-than-average returns? If you have years of experience with investing, your confidence will probably be higher than that of a new investor. Oftentimes, experience leads to greater tolerance for riskier investments. Before setting goals or determining your risk preference, it would be wise to consider your experience and confidence with investing.
3. How much can you afford to lose?
Weigh your possible risk versus your possible reward. Will losing a certain percentage of your investment portfolio reduce your standard of living in a significant way? Write down the percentage of your portfolio that you believe you can you afford to lose. When doing so, consider your budget (if you don’t have one, make one!), your employment stability, and your income. With a higher affordable percentage (or reservation price), one could potentially consider more risky investments.
4. Are you extroverted?
According to Psychology Today, psychologically speaking, extroverts are more likely to take risks than introverts. One theory is that extroverts are simply more comfortable with their surroundings. The idea of failure seems to scare them less and they are more likely to admit it when they’ve made mistakes. When it comes to investing, these are two huge mental barriers. Risk often scares investors because people naturally don’t like to fail and don’t like to admit when they’ve made a wrong choice. Knowing your own level of extroversion (high, moderate, or low) can help you decide what level of risks you’d be comfortable taking on.
5. Are you organized?
Organization is another huge mental component of investing. In psychology, this trait is sometimes referred to as conscientiousness. Conscientiousness in terms of investing can refer to a number of things from how often you check your portfolio to how much you worry about your existing investments. Investors with high conscientiousness typically restructure their portfolios frequently and worry more about their current investments, which would lend their investment styles more towards short-term or moderate-length investments. Less organized investors do not check their portfolios as frequently and don’t like restructuring often. Write down your level of organization and conscientiousness to help you determine your investment time horizon.
6. How often do you regret bad choices?
Think back to the past to times when you’ve made choices that weren’t ideal; how long did it take for you to get over those choices? Are you the kind of person who can forget about poor choices, label them as sunk costs, and walk away? Or, do you hold grudges and wish things had worked out differently? If you typically regret “bad choices” for a long time, extremely risky or short term investing might not be the best fits for your personality type. If you can walk away easily and not doubt yourself, you might consider more chancy investments. Knowing yourself in relation to your emotions and decision-making can make it easier select the most comfortable investments for you.
7. How big are your goals?
Think about your future. What are things you need to be able to pay for? What are the things you want to be able to pay for? Write these goals out in order to get a good concept of how much you’d like your money to grow and your timeframe to achieve those goals. Your personal goals can help you determine how much money you need to save and what kinds of investments you should make with that money. Plus, putting your goals in writing serves as a good, documented reminder of where you’d like to be some day.
Through the exercise of writing out the answers to these seven questions, you should gain a more concrete perception of your personality qualities and goals that should affect your risk tolerance, time horizon, and financial objectives. Keep these answers accessible as you invest because truly knowing yourself as an investor is one of the most important aspects in financial planning and in realistically achieving your goals.