.
Hi all,
I ran across some thoughts on risk in an email from the founder and
Chairman of AAII that pretty well mesh with my thinking of late.
Many will likely disagree, but opinions of these comments might make
for some interesting conversation. Sorry, there is no link, it’s from
an email.
Dan
(emphasis is mine)
… I am talking about the little known fact that most, if not all investors,
are far too conservative with the mix of assets they put into the market.
Risk is not watching your portfolio dip in a down market. “Real Risk”
is ultimately saving and investing for years, only to realize that you don’t
have the funds you need when you need them!
My historical research demonstrates that in almost all cases, individual
investors are grossly overexposed to so-called “safe investments.”
These investments sap the overall growth of your portfolio and are,
in effect an insurance policy that most of us will never ever need.
10 Likes
Hi Dan.
I bought and read the AAII book Dan cites, and I have to say that I agree with more points than I disagree with, but I won’t fully adopt his strategy. Just as I do here, I try and identify strategies that will make me a better investor while simultaneously fitting well with my temperament.
I think a key point of the author’s – that Dan touched on – is that most financial professionals equate volatility and risk. To minimize volatility, they suggest that you diversify into asset classes that are poorly-correlated with domestic stocks, but offer diminished historical returns (I seem to recall that Saul endearingly calls the most representative of those asset classes “certificates of confiscation”). The AAII author claims that volatility is not the enemy – subpar returns over long time periods is. And that the real risk is failure to meet your financial goals because subpar returns hold you back.
I agree with this and would encourage board participants to contemplate it. That is why – outside of a relatively small cash position – I am 100% in equities (a mix of domestic and international). But it really requires a certain temperament to execute such a strategy. I’ll readily admit that I blew it during the brief crash of 1987. But I learned my lesson and did not panic during the tech/telecom crisis or the financial crisis. The last eight years have been pretty amazing, but I think I still recognize that I’ll have to suffer through a few more crises in my life (should I be lucky to live so long), and that panic was counter-productive while sticking with the plan was quite beneficial, once the short-term pain subsided. If you can develop the temperament to stick with a very large equity allocation, you’ll have some REALLY bad years. But you’ll also reach your financial goals sooner than you would have otherwise.
I think the AAII author is on the right track in identifying the true nature of risk in investing. I credit Dan for bringing it to our attention. And I urge board participants to contemplate risk and volatility, and come to their own conclusions about where they appropriately overlap and diverge.
Thanks and best wishes,
TMFDatabaseBob (long: I’m a lifetime AAII member, having purchased that right in the early '80s; these days, The Motley Fool influences my financial thinking more than AAII does, but I still have some respect for the AAII approach to things)
See my holdings here: http://my.fool.com/profile/TMFDatabasebob/info.aspx
Peace on Earth
9 Likes
I’m already retired. Fortunately, I have sufficient income via pension, SS and a rental to cover my current needs. Future needs for my family are sketchy, I think.
I have discovered since following this board that my risk has come from dabbling in the market for years with no plan or strategy. Basically, latching onto one investment service or another and following tips. This has not served me well. I’ve never bothered in the past to even keep track of my annual performance.
I now have a spreadsheet set up that I update frequently and save a snapshot every month. The same spreadsheet keeps track of target and actual percentage invested in each equity for each of three portfolios and overall. Maybe that’s not a big deal for those that have been at it for a long time, but it’s pretty new for me and I find it a revealing and important tool.
I owe a deep debt of gratitude to Saul and the many contributors here who have helped me learn more about making money from investing, even with all the attendant risk.
4 Likes
I am talking about the little known fact that most, if not all investors,
are far too conservative with the mix of assets they put into the market.
“Real Risk”
is ultimately saving and investing for years, only to realize that you don’t
have the funds you need when you need them!
This is probably the first generation in history that is and will face a major part of their lifetime in retirement and few know how to prepare for it.
Typical working time these days is age 20 to 65–A 45 year timeframe.
Medical science will keep the average person alive to age 85 or 95 or maybe more—20 to 30 years of retirement beyond the 45 year working timeframe They statistically will keep you alive, but they won’t pay your bills to keep you alive with any dignity. If you are too conservative and run out of money by living too long, Then the FED or STATE will have to take over and we all know how much excess money they have to take care of you. If they don’t then you will have to depend on your children and if you are in your 90’s they could be in their 60"s or 70’s with their own medical and financial problems
Grandchildren could be in late 30"s facing parents and grandparents in need of long term care. They could become caregivers for 30 or more years and get everyone buried just in time to need care themselves. And there better be plenty of money around to pay for it all
Every 3 years of work (From 20 to 65) has to support you for the 3 years of work plus the 2+ years of retirement after you stop working (From 65 to 90+) and the increasing FED and STATE tax burdens that will be on your shoulders from the money you earn to pay your bills while in retirement.
And financial planners are telling you with a straight face you only need 80% of your working income in retirement and you can withdraw 4% a year. Nobody talks about inflation. They are paying $15 an hour to flip hamburgers in McDonalds–How much are you going to have to pay an aide or a nurse to wipe your a-s 25 years from now when you might not be able to do it yourself?
b&w
2 Likes
The reason ‘risk’ is equated with volatility is that it is mathematically tractable… therefore works well in B-school classes. Professors like it because it simplifies a complex topic into something handled by elementary statistics. It is the cornerstone of all the finance topics (MDP, CAPM, etc.), and entire careers have been built around it.
But, there is a problem. Volatility equates to risk only if your time horizon is myopically short, so short as to make a mockery of the word “investment”. The longer your investing time-frame, the less volatility plays a role.
Real risk is two-fold: That you suffer permanent loss of capital, or you fail to meet your investing objectives. Market movements over days or weeks are noise; the signal is the steady, almost boring rise of the value of successful companies over time.
I come from higher ed; I fully understand the appeal of a mathematically sound theory (my own field is physics, where if you don’t have the math, you got nothin’). But honestly, the entire field of finance has little theoretical background to rest upon. It is, literally, a house of cards.
Tiptree, Fool One guide, ranting
12 Likes
My historical research demonstrates that in almost all cases, individual
investors are grossly overexposed to so-called “safe investments.”
These investments sap the overall growth of your portfolio and are,
in effect an insurance policy that most of us will never ever need.
Hi Raptor, great quote. I liked this half even better. I know people who have been waiting largely in cash, for the “big crash” they know is coming, for the last six years at least.
thanks
Saul
4 Likes
Volatility is a risk unless you are an never ending endowment.
In the real world we get sick and we get old we may lose our jobs , all kinds of nasty stuff may happen.
If you really needed money in 1930 or 2009 you could say volatility was hurting you.
But except for 1918 Russia type events or less severe but closer in time 1974 Japan B&H has worked out well for most . Assuming diversification.
This topic is very timely to me as just today I think I came up w a solution for my tendency to keep too much of my investment portfolio in cash. While I am a working 46 year old, not a retiree, I am a commissioned based salesman w two young children. So, I do not consistently have cash flowing in for new equity purchases. My solution was to hold a large portion of cash in my portfolio to take advantage of large corrections. There have been a couple over the past couple of years and I have benefitted. But, even today I am probably close to 30% cash.
Since I already have a cash reserve for emergencies and my investment portfolio is mostly for long term needs, I think a large cash position for me makes no sense. But, as the market ascent continues on, it gets harder to get myself to pull the trigger on more buys.
My solution, which may seem ridiculously basic or obvious to some, is to replace my cash balance w the spy. If the market continues higher, I will benefit. Now, if the market tanks, I will start selling my spy and move into some of the higher beta stocks like SHOP, ANET, GWRE that I would like to own more of, but that I feel right now may be too expensive. Since these are higher beta stocks, they will presumably have corrected more than spy in a market correction, hopefully over corrected, and should tend to rebound more quickly than spy in a recovery.
Does anybody else employ this strategy? Does it make any sense?
Thanks
Treepak
1 Like
Hi Treepak
Yeh - actually I have done something similar in my UK high yield portfolio and I’m considering something like that here.
It’s not exactly the same as I’ve targeted a blue chip high yield ETF there rather than index but the point is the same.
What I’m considering here with my US growth port is having a core holding in an ETF that tracks tech and an ETF that tracks the small cap Russel index which usually outgrows large cap.
The advantage is - it’s a safer place to be holding cash than any particular stock but that might still appreciate.
Another advantage is it means I get exposure to Amazon, Google and Facebook without having to go out and buy each of them.
Ant
Ant:
Maybe you might like ADX (Adams Diversified Equities-) It’s a Closed End Fund currently selling at about a 19% Discount to NAV
The top 8 securities in their portfolio are
- Apple
2)Alphabet(GOOG)
3)Microsoft
4)Adams Natural Resources fund(Energy Resources Fund -PEO Trading at a further 18.8% discount to NAV- XOM Top holding 18% also Chevron and the other big boys)
5)Comcast
6)Wells Fargo
7)Facebook
8)Amazon.
Funds are in business since 1929 currently paying a 6% minimum per annum in 2016 ADX paid 7.9% and PEO paid 6.1%
In case you are curious XOM in the PEO Resources fund is discounted down 34.3% from current selling price
b&w
2 Likes
The strategy of replacing cash with SPY does not make sense because they are in no sense equivalent: SPY has become a high-risk investment while the downside of cash is 2-3% to inflation. To be remotely valid, you would need such a tight stop-loss on SPY it would be difficult to see a result.
The strategy of replacing cash with SPY does not make sense because they are in no sense equivalent: SPY has become a high-risk investment while the downside of cash is 2-3% to inflation.
Depends on how much cash you have on the sidelines. A small amount of cash (up to 5% of portfolio?) is not worth hedging. A large amount of cash is a totally different problem. Supposedly you are waiting for a fat pitch but all stocks tend move up and down with the market. Buying a market average fund seems self defeating, the cash value of your fund is going down as the fat pitch is being created.
This year I had some excess cash which I used to buy “cash equivalents” and it has not turned out well. I’m currently in the process of reversing those trades. I’m going back to my old strategy of holding a small amount of cash (up to 5% of portfolio?) supplemented by income from dividends and option trading. When a fat pitch comes along it will have to compete with other fat pitches and current positions.
High tech has been a thorny issue for me. It tends to outperform the broader market but a lot of it is quite incomprehensible for me. I’ve settled on three ETFs (semiconductors, internet and IT) to cover the segment adding quarterly as cash and portfolio diversification permit.
Denny Schlesinger
Nice find B&W thanks.
Ant