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Introducing Financial SEER: Samurai Equity Exposure Rule

Started by Sam, January 07, 2019, 08:13:05 AM

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Sam

So many people throw around the words "risk tolerance." But what does it really mean and how do you quantify it?

With Financial SEER, I quantify risk tolerance by calculating how many months of gross income would be required to make up for a loss in your portfolio.

I also use this Risk Tolerance Multiple to calculate what an appropriate equity risk exposure should be as a guideline for all.

Financial SEER formulas:

Risk Tolerance = (Public Equity Exposure X Expected Percentage Decline) / Monthly Gross Income

Maximum Equity Exposure = (Your Monthly Salary X Risk Tolerance Multiple) / Expected Percentage Decline

Detailed post is here: https://www.financialsamurai.com/seer-quantify-risk-tolerance-determine-appropriate-equity-exposure/

Feel free to discuss the metrics and how you quantify risk tolerance and appropriate equity exposure.
Regards,

Sam

jeff

Loved your post on this today. Glad you expounded on it so much after a brief mention of it in our discussion here.

Young And The Invested

Risk tolerance is always vague and spoken of in conceptual terms.  When people put values to it, it's in esoteric, non-relatable ways.  How does one define risk?  What exactly does it involve?

One way to define it is through synonyms: hazard, danger, jeopardy, peril, etc.  None of these sound particularly desirable when describing investing.  But none of them really elicit that visceral response we feel when you're fully invested and the market plummets.  You've no scratch left to take advantage and you're stuck in these "volatile" investments.  When you're in that moment, "volatile" doesn't seem to describe risk accurately.

In finance, people equate risk with volatility.  They do this because it represents the unpredictability of an investment.  In abstraction, I suppose it makes sense.  But in practice, volatility, or the movement up and down without clear discernment of direction, doesn't fully capture the true notion behind the idea of risk.  At least not in my opinion.  Personally, I don't feel volatility is the risk most investors care about.  I think they care a lot more about the risk of loss.

Can you imagine someone stating they wouldn't buy a stock because it fluctuates too much?  Or in reality, would you imagine someone saying they wouldn't buy a risky stock because of the potential for loss?  I think people feel risk represents a loss of capital or an unacceptably low return, as you attempt to quantify in your post, Sam.  Your methodology is certainly not absolute, but it does a great job of framing risk in relatable terms.  By basing it in something more concrete, like years of salary required to recoup losses from "risky" investments, it becomes more understandable.  That's my takeaway from your framework.
https://youngandtheinvested.com/