Is this a valid way to find my risk tolerance?
So we've presumably all done those risk profiling questionnaires and are eventually mapped to something like conservative, adventurous, 4 out of 5... but how are those things mapped in the first place? Who's to say that adventurous corresponds to 100% equities other than convention?
I'm exploring a different approach and would love your comments on it, but basically I'm trying to use these extreme days to measure the limits.
Basically, on a big red day, did you come close to the following:
\-deviating from your financial plan?
\-calling your financial advisor?
\-consider selling your investments?
\-lose sleep or feel anxiety and stress?
\-post some panicked thing like this on reddit?
If so, I'd argue you were at your tolerance limit and form there we can backward out your tolerable allocation.
For example, if I lost $25,000 on a $1,000,000 portfolio in a day and considered liquidating my investments, then a 2.5% loss in a day is my tolerance limit. I didn't break it, but I was close.
I get that bad days happen, how often can I stay the course when days like these occur? Are they acceptable every 30 days? every 100 days? every year?
Let's say I can accept a day like that every 160 days, then I can figure out my sigma which is normsinv(1/160) = 2.5 stdevs.
Let's convert my 2.5% loss to an annualized vol with 2.5% \* sqrt(252) = 39.69%
Based on our frequency we're saying that 39.69% is 2.5 stdevs, so 1 stdev should be **15.87%**
From this annualized target volatility, we can find portfolio allocations that match our tolerance. At 15.87%, I can still do 94% equities 6% bonds.
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How do you guys feel about this approach? I think it's more actionable than being rated on a scale of 1-5, or "adventurous"?
\*What are the behaviors that you think mark that someone is at their risk tolerance limit?
I realize there was a wall of math text above so I made a quick app to illustrate the calculation method I was describing. [https://risk-tolerance.replit.app/](https://risk-tolerance.replit.app/)