Financial vs. Emotional Capacity for Risk: The Importance of Weighing Both When Building An Investment Portfolio

Your investment strategy should be determined by the lesser of (1) your financial capacity for risk and (2) your emotional capacity for risk. Otherwise, you are likely jeopardizing your financial goals.

What’s the difference you ask?

Financial capacity is the ability to achieve your financial goals even after a severe stock market decline.

Emotional capacity is the ability to stomach volatility and losses in a severe stock market decline.

A couple examples will help illustrate these concepts.

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Free Beer! But First…What Free Beer Teaches Us About Economics

Wedding season is almost upon us. I love weddings. When I think of weddings I think of dressing up, mingling with friends and family we haven’t seen in a while, fancy venue, and… free beer.

I’ve experienced weddings from a few different perspectives: as a guest, as the co-star, in a supporting role and as the bartender. Bartending is a great gig for a college-age kid by the way.

Bartenders are notoriously observant…especially once the guests are loosened up and start filling the dance floor because this is the time when things start to slow down for the bartenders giving them a chance to really observe the festivities. Not long after this point (sometimes it feels far too soon when you’re a guest) the party begins winding down, and the cleanup begins.

But you don’t need to be a bartender to make the following observations. In fact, I’m sure you’ve already made these observations:

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Household Debt

Household and Nonprofit Organizations Debt exceeds prior peak set in Q3 of 2008 during heart of the financial crisis. Although, it remains lower than the prior peak when measured in terms of GDP.

Both student loans and auto loans are sharply higher than Q3 of 2008.