The eat well, sleep well adage refers to the risk/return trade off with regards to investing. The trade off is between the decision of whether an investor would like higher returns (eat well) or have peace of mind with less risk and lower returns (sleep well).
Everyone has a different tolerance for risk. It can depend on may factors.
important criteria when considering investment risk
Your age
The younger you are the more risk you can take with your investments. This is especially true if you don’t need access to your money in at least the next 15-20 years. The reason behind this is even if you do experience poor market performance, you will have plenty of time later on to recover your losses. High risk investments such as stocks can have volatile returns with large up and down swings. In compensation for the risk you are taking, you are hoping for better returns than you would get from lower risk investments such as bonds.
Conversely, someone about to retire may be much less willing to take on too much risk. At that age it may be much more important that you enjoy peace of life over the potential volatility of an investment. A common fear among retirees is outliving their money. Lower risk and sleeping well is their biggest priority.
Your personal situation
If someone has dependants such as a stay at home partner or children, then they are probably less willing to take risks. It is not just their life they are responsible for, but also for others. Or maybe you have a job that is on a contract or in an unstable industry. Or perhaps a very large mortgage that would come under pressure with the smallest of interest rate hikes. All these factors contribute to a less than secure personal situation where investing risk should probably be minimised as you are less able to manage 'shocks'.
Your attitude
Some people just have very low or high tolerance for risk regardless of their age or personal situation. Just because someone is young with no family they may have witnessed someone or experienced getting burned by risky investments. They may now be gun shy for no other reason than a recent experience. This is known as the recency bias. It is a bias as just because something bad happened recently, does not mean it will happen again. The person experiencing this bias feels even more afraid about investing than they did before this experience. This may result on missing out on great future returns.
Whereas some people can have a blasé attitude to investing where they take on high risk without truly understanding the consequences. This is typical of someone with an attitude of overconfidence. Physicians are prone to the overconfidence bias. They save lives for a living and are prone to thinking “we save lives for a living, how hard can a little investing be.” An overconfident person will routinely seek risky investments thinking they can do better than the professionals. They are driven by their desire to eat well, not sleep well. Not until they experience a real setback may their eat well, sleep well trade off become more balanced. Others may realise the consequences of losses, but not actually care. We all have different attitudes to investing.
Final Thoughts
There are several ways to reduce investment risk that I have written about in part 5 of the investing for beginners series. In part 3 of the investing series I discuss the various risks of different types of investments. Did you realise that investing your money in a bank savings account also carries risk? There is a significant risk that inflation will grow at a rate faster than your savings, meaning that your money is worth less than when you made the investment.
Understanding risk will go a long way towards allowing you take on risk and still feel good about it. The more we can understand something, the more we can find ways to mitigate the risks. The less we understand, the more we open ourselves up to unexpected outcomes that could stunt our ability to sleep well.
The question of do you want to eat well or sleep well implies the answers are mutually exclusive. The truth is you can do both. If you implement some of the tips I recommend in my investing series articles you can invest in relatively risky investments whilst managing those risks to some degree. Also remember that just because an investment is risky, it doesn’t necessarily make it a good investment with high returns. Only you can determine your optimal balance of where you feel comfortable with the risk you are taking on. If you read the 14 part investing series for beginners you will be well on your way to confidently making decisions with regards to an investment strategy that best suits your investor profile.
You need to find a level where you can sleep and eat well. Sleep too well and you won’t have enough food to sustain you. Eat too well and you run the risk of running out of food. Is that extra risk worth the sleepless nights? Find your balance.
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The information contained on this site is the opinion of the individual author(s) based on their personal opinions, observation, research, and years of experience. The information offered by this website is general education only and is not meant to be taken as individualised financial advice, legal advice, tax advice, or any other kind of advice. You can read more of my disclaimer here