What Is Your Risk Tolerance?
Posted on 8/2/2012
Whenever someone sits down with a financial consultant to make investments, one of the first questions they might be asked is “What is your tolerance for risk?” This question is very important for several reasons, and can be applied to your numismatic purchases as well. The fact is most people are very conservative when it comes to investing. The financial consultant will gauge your ability to handle risk and make investment suggestions based on your answers. All investors hate to lose money. It has been said that the joy of potential profits is far outweighed by the fear of losing money. That is why investors generally choose a mix of investments that will spread risk and avoid a sharp decline in portfolio balances. During the heights of the financial crisis there was virtually nowhere to hide for investors. Most sustained heavy losses and could not stand the thought of even opening their monthly statements. For many this was actually a good idea because if they had studied the results of their investments they might have panicked and sold at the bottom. The markets have slowly recovered over the last few years and investors are hoping to catch up for years of lost time in their retirement accounts.
For rare coin buyers assessing risk is sometimes an underrated exercise. As with any investment, coin collectors should weigh the upside and the downside of any purchase. Whenever I purchase a coin for inventory, I carefully decide the potential profit for that coin. The potential profit is important, but equally important is the possible downside of the purchase. Most professional rare coin dealers buy thousands of coins each year. In the long run we make money on the majority of the coins, but losses are an inevitable part of the business.
When I am offered an expensive coin I run through a basic math equation to determine if the coin represents a sound purchase. Let’s say the seller is asking $10,000 for a certain coin. I will check current price guides, population information, and recent auction records. Hopefully, I will also have handled an example of the issue at one time or another. After close study, I might determine that in the worst case the coin would bring $9,500 and if things work out, the coin could sell for $12,000. The potential $2,000 profit outweighs the possible $500 loss. In other words I will tolerate risking $500 for this purchase. Some rare coin buyers can’t stand to lose money on a coin and would rather pass on the opportunity of making the $2,000 profit. Much of this also has to do with confidence in one’s ability to determine the risk. I believe that is the key ingredient for any successful rare coin dealer or collector.
As I have stated many times in these articles, knowledge is the most useful tool when making a buying decision. With the proper knowledge, you can have an understanding of the risks involved in rare coin purchases. That is why many collectors do much better when they pick a series and focus their energy on understanding the factors that determine the value of the coins they collect. If you have a low risk tolerance, as most do, you should make your purchases based on facts that you fully understand. Occasionally, collectors will have to get out of their comfort zone when something comes up that is rarely offered. When I have the chance to purchase a rare coin that seldom comes to market, I am willing to handle more risk. I know that someone else will probably appreciate this rare opportunity and offer me a profit. Collectors are in a similar situation. If you can buy a great coin, you can almost be certain that another collector in the future will also want this great coin. The key words here are “in the future.” Never stretch to buy a great coin that you might need to sell relatively soon. You might not quickly find someone who is willing to stretch as you have and you could be faced with a substantial loss. This comes back to your risk tolerance.
In general, collectors should make an effort to assess their tolerance for risk when making an investment in rare coins. As with other investments, your timeline for investing is also extremely important. A stock advisor will ask if you are investing money you might need sometime soon. Obviously, if you might need the funds in the near future, you should avoid risky investments that might drop sharply and take years to recover. Investing in coins should also be for collectors who think long term. For collectors buying over a period of years, price drops can be an advantageous time to make purchases. This sort of cost averaging generally works out in the long term. Many of the greatest collections took decades to assemble and the resulting returns were spectacular. Collecting rare coins can be a passion, but nearly every buyer is concerned with the financial results of their pursuit. As with your other investments, consider all factors when making a purchase decision. Your long-term results will hopefully bring you years of enjoyable collecting that also turns into a great investment!
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