Reader Risk Assement: Some of You Are Crazy

by Kevin on April 18, 2008

Little Case by Banalities

On Monday I asked you which briefcase you would choose: a coin flip on $250,000 or some other guaranteed amount. I also asked what that guaranteed amount would have to be for you to not take the coin flip. So if the other briefcase contained $50,000 would you take the guaranteed $50,000 or still do the coin flip.

As you might imagine, there were a wide variety of answers. You aren’t all crazy, just some of you.

  • Mike said it would have to contain $125,000 or more.
  • Wide Open Wallet said $25,000.
  • Jeremy said enough to cover his non-mortgage debts, although didn’t say how much that would be.
  • Amphritrite said $200!
  • Lynnea said $20,000.
  • Stephanie said $10,000.
  • Seb said $100,000.
  • Eric said $10,000.
  • On a forum I participate in, someone said $250,000!

As you can see, a wide range… $200 to $250,000.

This is a Risk Assessment Tool

As some of you have probably guessed, this is a risk assessment tool. The lower the amount of money you would accept to avoid the coin flip risk, the lower your risk tolerance. The more you will accept, the higher your risk tolerance.

The expected value of coin flip case is $125,000 – ($250,000 x 50%) + ($0 x 50%). If you have to have anything more than this in the case, you might enjoy risk. (In my opinion, you might enjoy it too much!) If you would accept $125,000 you would be considered risk neutral. I don’t believe anyone is truly risk neutral. If I opened up the case and showed you $120,000 I would bet 99% of the time that person would take the case. I know I would gladly give up $5,000 to guarantee $120,000.

Personally, my number is $10,000. That is a very healthy payday for no work. Don’t get me wrong, $125,000 for no work would be great, but landing on the wrong side of the coin would, in a word, suck. We wouldn’t retire off of ten grand, but it would help us move along toward that path.

Lessons Learned:

  • Everyone has a risk tolerance. Learning and knowing this can help you understand previous decisions you’ve made as well as guide you in your future decision making.
  • Risk tolerances vary greatly from one individual to the next. This can make communication difficult, especially in a relationship. If your spouse can accept a high level of risk and you can accept none, there may be a few bumps in the road ahead.
  • Understanding the expected return or expected value of two different opportunities can help you make better decisions.

What would I do with $10,000? Fund the rest of our Roth IRA’s for the year, and add the extra to our emergency fund. Plain Jane, but still sticking to the plan.

(Photo: Little Case by Banalities.)

Comments on this entry are closed.