November's columns focus on risk. I am still searching for the best definition of the term. Earlier this week, I came upon one that ranks as the front-runner so far: Risk is the probability of not having enough money to buy something really important. Take that, statisticians!
In this column and the next we will ponder some questions and responses to investment-related events that will help us to understand how we relate to risk. Our ultimate goal is to have better insight into which investments are likely to suit us best.
Many risk profiles focus on life stages and financial needs. However, temperament is a bigger determinant of your appetite for risk, regardless of your age.
According to investment guru Warren Buffett, the most important quality an investor should possess is the ability to go with or against the crowd, gaining your confidence from solid reasoning and neither from being "in" with the
trendsetters nor from being contrarian just to be different.
Consider the following six situations and circle your most likely response:
1. What would make you the happiest?
a. Doubling your money by investing in shares; or
b. Being saved from a market collapse by having your money in cash?
2. You're on a television game show. What do you choose?
a. R1 000 in cash;
b. A 50 percent chance of winning R4 000;
c. A 20 percent chance of winning R10 000; or
d. A five percent chance of winning R100 000?
3. You are at a casino and you've just lost R500 at blackjack. How much are you prepared to lose to win it back?
a. Nothing - it's time to go home;
b. R100;
c. R250;
d. R500; or
e. More than R500?
4. What would leave you happiest?
a. Winning R100 000 in a writing contest;
b. Inheriting R100 000;
c. Making R100 000 from a R2 000 options punt; or
d. You don't mind how you get it, as long as you get R100 000?
5. It is June 2004. You finally manage to get some MTN shares at R33. The market corrects and in a few weeks the share has dropped 15 percent. Assuming there is no fundamental reason for the decline, do you:
a. Sit tight - it will go up again;
b. Sell it and sleep better;
c. Buy more - it must surely be even better value now?
6. You hear that developers are showing a lot of interest in a piece of undeveloped land. You can get an option on the plot, but it will cost you two months' salary. On the other hand, you can make five times that if the option works out. Do you:
a. Buy the option; or
b. Let it slide - there are too many unknowns?
Allocate points to your response to each question as follows:
1. a = 2; b = 1.
2. a = 1; b = 3; c = 5; d = 9.
3. a= 1; b = 2; c= 4; d = 6; e = 8.
4. a = 2; b = 1; c = 4; d =1.
5. a = 3; b = 1; c =4.
6. a = 3; b =1.
Note your score. There will be more questions next week.
- With acknowledgements
to J. Ware.