Never forget these two axioms:
Money frees us, but its pursuit may enslave us.
It’s not how much you have at the end; it’s how much you could have made.
Risk: A Game of Not Global Domination, But Financial Planning
Before determining what you’re buying at what price in what quantity and keeping said security for whatever length of time, you need to decide for yourself (and your family if applicable) what you want as an end result of your investing and what risk you’re willing to take to hold them as an investment.
Realize that all investments contain risk.
ALL.
OF.
THEM.
By risk, we mean that you will lose money on said investment, possibly even all that hard earned money you put in originally.
We all do this every day as doctors. As we take care of patients, we weight the risks and benefits of each treatment or testing option and move forward with the most beneficial course with risks ranging from none to tolerable to even high.
That’s essentially all investing is when talking about what is known as risk tolerance.
Virtually all securities that return a greater amount of money carry a higher risk than those that return a lesser amount.
Unfortunately, risk and return are directly related.
In my mind (and perhaps mine alone), it’s like why all the best tasting stuff is bad for you and the healthiest stuff tastes…meh.
ANYWAY…
In reverse order of risk:
Bonds carry low risk.
Federal or AKA Treasury bonds (bills and notes too, but I’ll just say bonds moving forward for the sake of convenience) are considered risk free because of the almost metaphysical certitude by which they are paid. The US government would have to completely fold and not pay anything ever before bond payments stop . If you recall, you as the bondholder are the creditor that is owed money before the debtor (in this case, the US government) goes bankrupt. Given the fact that the US government can literally print as much as money as needed for any reason under the sun (reading this again as I proofread this post…this explains a lot of what is perhaps wrong with our current polticoeconomic situation), it’s virtually impossible to have US Treasury bonds default. Thus, risk free…
Municipal (AKA US city or county) bonds are slightly higher risk than federal bonds, but lower risk than any other widely available security. CIties (or counties or states) would have to go bankrupt before bonds issued by them became worthless. It can happen (hello again, Detroit! Also, hello Stockton, California!), but it’s extremely rare, may not affect these bonds while the city or county or state government “reorganizes” its finances, and is easily avoidable in the first place by knowing which areas are fiscally distressed. The latter is easily found out by a five minute Internet search into the area that is issuing the bonds or just simply (here’s a novel idea!) reading/listening to the news and being aware of the world around you. Remember that there may be extra tax benefits to certain municipal bonds which may make the juice worth the squeeze.
Corporate bonds are still safer than either stocks or funds by quite a bit (provided that they are not the often talked about and greatly derided/feared junk bonds), but less safe than other aforementioned (What a great word! You literally cannot sound stupid saying it) types of bonds. As expected, the riskier these bonds the higher the yield, And the lower the yield, the lower your risk you have to endure to get your money.
Mutual funds and ETF’s carry a risk in between bonds (lowest) and stocks (highest risk). The collection of stocks and/or bonds will offer downside protection because even as some stocks fall, other will rise or at least stay even.
Stocks offer the highest return of the Big Three widely commercially available securities with the highest possibility of downside. Just ask anyone who suffered through the 2008-2009 Great Recession.
In 2008, the S&P 500 finished the year 37% lower than it opened.
This is what the risk averse and haters of the stock market in general or stocks specifically bring up as soon as the topic of investing comes up. Even if you had suffered through the brutality of the 2008 market (which didn’t hit its bottom until March 2009 actually), the market went on a tear that hasn’t slowed down since. In fact, it’s been on a rocket since 2017 began.
The annualized return from January 1, 2009 to December 31, 2017 (thus even including the terrible months of Jan-March 2009) is 15.29%.
SR: Uh, yeah, stats guy. That’s great and all…IF YOU’RE A NERD!!! What does that mean in real dollars?
PWT: Sure Great question. After all, that’s why we’re all here.
SR: Nah. I’m mostly here to crack wise. I’m like a digital Statler…or Waldorf…or both.
PWT: Not one millenial here has any idea what you’re talking about right now.
SR: Ah, shut up, money man.
PWT: Anyway…
For every $100 you had in the stock market (not bonds, cash, etc.) at the start of 2008, you would have $63 at the end of that same year.
SR: Ouch
Dr. Scared: This is it!! This is how they screw you!
For every $63 (the amount left from the original $100 once reduced by the annus horribilis of 2008) in stocks starting at the beginning of 2009, you’d have $226.80 on January 1, 2018.
So, 226% increase since 2009.
Not bad.
Even if you include 2008, the worst performing year of the last three decades in the stock market, you had a 8.49% per year annualized return in a S&P 500 only portfolio from Jan 1, 2008 to Dec. 31, 2017.
SR: Hey there, guy, I just need…
PWT: We know, We know.
For every $1 you put into the market at the start of 2008, you would have wound up with $2.26 by the end of 2017…and that’s with surviving the worst year in recent memory.
For those who would argue that they would have retired in 2009 if the stock market hadn’t crashed, then you likely weren’t positioned for retirement in the first place. (Much more about this in a later post.)
Also, this assumes you were only in stocks, not any outperforming fund, bonds, any alternative investments, or just cash (always in style, always fits, and never gets old). Even if you had 100% of your portfolio in only stocks, and then decided to not see the 2008-2009 crash as a buying opportunity (but hopefully not as a selling point either), then you would have been forced to work until 2012 ended. (If you worked through the end of 2011, your stocks only portfolio would be 94% of its January 1, 2008 value.)
The above is predicated on two basic assumptions:
- ) Your stocks only portfolio is completely identical to the gyrations of the S&P 500.
- ) All dividends were included and calculated in these returns.
This shouldn’t scare you off from the stock market, but rather convince you that you need to always be cognizant of your age, your net worth, your closeness to retirement, and what your Magic Number is.
Therefore, the closer you are to your Magic Number, the more you need to be oriented towards maintaining your net worth (what is known as capital preservation) rather than growing it further.
ANYWAY…
Think of risk tolerance as an individual exercise. Don’t worry that yours may be dramatically different than your best friend’s, colleagues at work, etc.It should be different. In fact, I’d be worried if your risk tolerance is the same as everyone else you know.
Think of it like this.
How do you drive? How aggressive are you? How fast above the speed limit are you willing to push it on a highway? How willing are you to hit bumpers when you have to parallel park?
There’s plenty of online quizzes that test your risk tolerance as an investor that you can search for, but none of them are much better than thinking about what kind of driver you are.
It all boils down to the following:
Aggressive investors are willing to lose money in the short term in order to make outsized gains in the future/long term.They’re exchanging security for better returns.
Conservative investors are willing to have lower returns as long as their original investment is preserved and gradually increases in value over time. They’re exchanging returns for security. Or, as some might say, they’re exchanging returns for peace of mind.
And there are moderately aggressive investors that have a blended approach between the two which is likely where the vast majority of us are.
Just reading this probably tells you where you lie based on how you felt as you read that last passage.
It’s easy to be critical of others that aren’t like you, but being more aggressive than you’re comfortable and working on an ulcer rather than sleeping each night is nothing to brag about. But, people do it all the time. I know some that do. I’m sure you do as well.
Grousing about how well the market is doing and bitching about it all the time when you’re investing too conservatively for you and your family is nothing to celebrate and is certainly is not any way to live.
Personally, I’ve always been an aggressive investor and it has been great for me. But, realize what that means. You don’t have to be invested in companies you don’t understand like high technology (ie, AI, cloud computing, cybersecurity, etc) companies, but rather blue chip Dividend Aristocrats along with index funds which will get you great returns, but still categorize you as an aggressive investor. I always wanted to ensure my investments after any fees and taxes were subtracted out was significantly above inflation (3.3% on average, remember?). At the end of the day, though, you need to invest to your style and comfort and no one else’s.
What is your risk tolerance?
Think about it.
If you’re married or in a seriously committed relationship, talk to your spouse or partner about it. Hopefully, if you’re not on the same page, you can find a very terrifically happy medium.
I’d love to hear from any and all of you about your thoughts, so we can all learn from one another.
Please spread the word about this blog to your friends (real and virtual), family, and colleagues.
Talk to you soon.
Until next time…