We’re all getting a lesson in what our true preferences are

Days like today are what behavioral finance and investment risk tolerance questionnaires attempt to get at (but do a poor job of).

Typically, these questionnaires ask some version of the following:

“If you owned a stock investment that lost about 31% in three months, would you: A) Sell all the remaining investment B) Sell a portion of the remaining investment C) Hold onto the investment and sell nothing D) Buy more of the remaining investment

Many investors know the optimal response to this question. But this question (termed “stated preference”) doesn’t matter, because it’s low stakes. It gets asked when people aren’t in a heightened emotional state.

What we’re seeing with these past few days of volatility are what people’s true preferences are. Emotions are heightened! Can they actually handle the ride? Can they accept remaining invested as markets go down? Are they actually looking at this time as a buying opportunity (and are they actually buying)?

Whatever actions you, me, and everyone else are taking right now are revealing what our true preferences are (hence the term: “revealed preferences”).

I have no advice to give people here other than to take note of what you’re doing right now. What are you feeling? How difficult are you finding it to sleep? Note it down. And maybe update how you responded to those risk tolerance questions you were probably asked when you opened your account.