Don't Try to Predict Your Own Behavior

"It's easy to see, hard to foresee." ~ Ben Franklin

How often have you accurately predicted your reaction to emotion-provoking events in your life?

When the stock market gets volatile as it has been in recent weeks, I am reminded of the irrelevence of risk tolerance questionnaires.  If you've ever sat down with an investment advisor or financial planner, you've likely seen or heard the questions that try to predict how you might react in various stock market scenarios. 

For example: 

"If your investment portfolio were to fall by 20% in the course of one year, how would you react?  Would you A) Do nothing, B) Wait a few months to make a decision, or C) Sell your stocks immediately?"

After answering about 20 questions like this, the advisor or planner then assesses your risk tolerance and will likely label you as one of three investor types--aggressive, moderate or conservative.

"A man’s knowledge is like an expanding sphere, the surface corresponding to the boundary between the known and the unknown.  As the sphere grows, so does its surface; the more a man learns, the more he realizes he doesn’t know.  Hence, the most ignorant man thinks he knows it all." ~ L. Sprague de Camp

The problem I have with these questionnaires is that no human being can consistently or accurately predict their own behavior, especially if they've never experienced the scenarios given on the questionnaire.  I have several clients who had once thought they were "aggressive" investors--able to tolerate high risk, high volatility--but were ready to bail out of stocks immediately after a 5 or 10% decline.  This is not poor judgment on their part--it is simply human.

Consider life scenarios.  If your spouse died, how would you react?  If you lost an arm, what would you do?  If you survived a terrible car crash, what emotions would you be feeling just moments after it occured?  The honest answer is "I don't know."

"Fantasy may call the grapes of reality sour, but those who have tasted them know at last a dependable delight." ~ Dorothea Brande

Predicting behavior is at the root of most failure.  For example, something that seems difficult to endure is often not as terrible as you might imagine; but because you hesitate or fail to make an attempt at accomplishing a goal, you fail.  Conversely, you may imagine something causing extreme happiness so you pursue it.  However, if and when the thing is obtained, the happiness fades quickly or doesn't happen as you had once imagined.

Humans underestimate their ability to endure difficult times and they overestimate the happiness they will feel.  Therefore the seemingly difficult goals might never be attempted and the pursuit of happiness can be misleading.  The most accurate prediction, with regard to your future behavior, is that your prediction won't be accurate.  Embrace transcience; be content with the way things are now; be satisfied with not knowing the future or attempting to control it; and allow your imagination to be your friend, not your enemy.

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Related:

Understanding Markets: Nature Not Naivety or Narcissism

We Are All 'Naive Scientists'

The Experience-Stretching Hypothesis

Comments

[Leone]

Kind of reminds me of those who waist their time and energy preparing for an event, usually for the worst.

Perhaps we should focus on we can react post an event as opposed to planning before, only to not have the character to act.

I always find your posts engaging Kent,
Many thanks,
Leonardo

[Kent @ The Financial Philosopher]

Leonardo:

Yes, as often as possible I am a "cross-the-bridge-when-I-get-there" person. So often people get anxious thinking about possible outcomes that may or may not occur. And if they do occur they are not as imagined.

This quote comes to mind here:

"My life has been full of terrible misfortunes most of which never happened." ~ Michelle de Montaigne

[Andrew]

Great post Kent I love how it ties in with the previous post.

It is the paradox of imagination it can be so powerful and useful but also hinder and hold us back, best summed up in these two quotes?

“Logic will get you from A to B. Imagination will take you everywhere.” Einstein

“ The more you observe life in relation to yourself the more you will see the fact that you are hardly ever correct when you think about something in the future. The future exists only in imagination; and that is why, no matter how hard you try to imagine it, you will not be able to predict the future with total certainty. ”
Barry Long

[Master And Student]

Most investors and traders try to predict and err. Instead, if they could prepare themselves and react, they could possibly make it a day.

[kalamazoo financial planner]

I think the best thing to do in life is to just "roll with the punches." Live life day to day. This article was an interesting way to talk about investment risks.