Are you risk averse? Why??

[JamesR]

I've seen that there are some people on this forum that appear to be highly risk averse, and are seeking less than 3% interest overall in their investing.

I'm concerned that there's a combination of math fail & lack of understanding of risk here. Also don't forget inflation is 2-3%!

Perhaps it's human nature to have too much of a tendency to focus on possible drawbacks on your investments, but why not focus on how you will deal with it in your awesome ERE lifestyle & side income streams. (P.S. Awww, the market drew back 50%? Boo fucking hoo, it'll come blasting right back in a couple years, good thing you were already living below your means and you didn't even notice the drawback.)

If you're younger than 60, it doesn't really make sense to be hugely risk-averse. If you're older than 60, maybe it makes sense.. But does it really?

Putting all your money into index funds, and then having the market crash every 5 years is totally fine. You'll still be far ahead compared some ridiculous 2% guaranteed interest rate.

In fact, I'm tempted to get my parents to put their all their $500k into index stock, and guarantee a minimum for them so they stop with the bloody risk averseness. Thoughts?

[Ian]

Are you sure people are actually seeking 3% returns? I throw that number out often, but even my most conservative investments are returning more than that. It's a question of avoiding overoptimism, not of fearing anything that involves risk.

Having said that, I am far more cynical about the future of everything than you are. Stock markets have only existed for a relatively short period of time at the tail end of a long history of systems dying. I'm invested in stocks - it's not like I'm living among piles of tin cans and expecting the collapse of civilization. But we have plenty of examples of stock markets crashing for long periods (the third world) or declining even longer (Japan). The US has always been different, but that's only because it holds a singular position. Unless current trends change, I expect all positions to be continually eroded throughout the course of my life.

[rube]

I am with Ian.

And how are you gonna guarantee the 500K (or min. amount) to your parents? There is *NO* 100% guarantee ever...

[Ego]

Experience with the tech bubble.

[JamesR]

rube,

I meant I would guarantee something like a 3% SWR on the $500-600K, if they invest according to how I want them to. That means approximately $1500/mo. If their returns drop so low they can't risk withdrawing the full amount for that year, I would guarantee I would cover the difference until the market recovered. A lot would have to go bad before I had to cover _anywhere_ near the full amount, and if it truly was that bad, then that's a whole different ballgame, and things are going to be happening worldwide. I could possibly take 1% for my guarantee during good years, and use that to help me ensure the guarantee going forward as well.

Ego,

And yet there's always bubbles. Bubbles is a way of life. It shouldn't make people risk averse. If they sold after the crash happened (and didn't need to sell), then it wasn't really the market's fault or their lack of risk-averseness prior to the crash fault that they lost their money at that point.

[elegant]

29 years old. Current net worth is 240k USD. Maximum projected annual expense is estimated to be 8500 USD (Likelier scenario is 6,000 USD).

I limit my exposure to stocks to 50%. The rest of my stash is in cash and bonds.

Am I able to take more risk given my age? Of course.

Do I need to take more risk? Not really.

My SWR is almost 3.5%. Practically speaking, I have already won the game. Hopefully the 50% stocks portion will provide enough growth to protect me from inflation for years to come, while the cash/bonds portion will dampen volatility during bear markets.

Just as I'm not willing to work for 4-5 more years to decrease my SWR and make it even more bulletproof, I am not willing to take unnecessary stock market risk.

[mxlr650]

In fact, I'm tempted to get my parents to put their all their $500k into index stock, and guarantee a minimum for them so they stop with the bloody risk averseness. Thoughts?

If you can guarantee minimum income to your parents (and provide them with additional funds when needed) it would make a good approach.

I have really low risk aversion — as a data point, I was rarely bothered let alone thought about selling stuff when my net worth dropped by ~50% (house value, investment account). The plan is to continue this aggressive investment profile for another three decades. At retirement we will be mostly self-sufficient, and if there are multiple failures, I have no problems looking for jobs. We likely will never spend away our networth – so investing is a hobby/game for me. Its also another way to say FU to the money. Our investment profile will change midspan if a disaster strikes and if one or both of us end up needing constant care.

[5to9]

One of the things that I love about this community is that we tend to challenge the beliefs that others accept unquestioningly. I think that "the US stock market is going to go up over time at >X% rate, guaranteed, no question, no matter what price you buy in at" is one of those beliefs. We all come to a wide range of conclusions based on our own assessment of the risk/reward profile (I'm still working on mine), but the fact that we do our own research is what makes this more interesting than the boglehead forums to me. Just go try having a discussion there about alternatives to indexing and see where it gets you

[George the original one]

Different goals will partially explain different risk tolerances. If you've made a sufficient pile, then there's less incentive to take extra risk than is necessary to maintain the income.

True ERE seekers (as opposed to ER), will have piled up their resources in a very short period of time and not likely had time to practice and experience risk-taking strategies. Being an ER candidate and having seen several market upheavals, that's partly why I started the leveraged income experiment... to show how a particular strategy with higher risks can play out.

[Tyler9000]

(P.S. Awww, the market drew back 50%? Boo fucking hoo, it'll come blasting right back in a couple years, good thing you were already living below your means and you didn't even notice the drawback.)

It doesn't always come blasting back.

The inflation-adjusted returns of the stock market for any period starting in the 1960s ranged between -1% and 2% annualized over the next 20 years. That's before taxes. It recovered to 3-4% annual real returns if you waited another 5-10 years. More recently, the period starting around 2000 isn't too different.

The relevant question is whether you as an investor (and especially an early retiree) would be willing to wait more than two decades for your investment choices to start paying off the way you expected, or would you tinker with allocations after a year or two, locking in losses in the process? How strong is your faith?

What you see as risk aversion others see as wise money management based on a measured evaluation of their individual goals, timelines, and investing personalities.

And then there's the issue of "enough". If one does not need to take heavy stock risks to support themselves, why should they? For some people, a solid financial base to allow them to patiently hunt for investment or work opportunities is exactly what makes them happiest.

[mxlr650]

The inflation-adjusted returns of the stock market for any period starting in the 1960s ranged between -1% and 2% annualized over the next 20 years. That's before taxes. It recovered to 3-4% annual real returns if you waited another 5-10 years. More recently, the period starting around 2000 isn't too different.

Why 1960? If we are looking into future, what possible point can it illustrate that is applicable to just stock portfolio but not PP?
All simulations I have done (Firecalc, Vanguard) on stock-based portfolio report no failures (running out of money) for any time period with even the most aggressive portfolio as long as SWR was below ~3%. So an SWR <3% can weather all the market trends seen so far, so it is really irrelevant how long the portfolio needs to be invested in the market. Some cannot handle the portfolio churn, but that is more of an investor emotion factor.

What you see as risk aversion others see as wise money management based on a measured evaluation of their individual goals, timelines, and investing personalities.

And then there's the issue of "enough"

We all acknowledge that future trends are unknown, so it is quite likely that anything that worked in the past may not work in the future. This is applicable to stock portfolio or PP, and claiming one approach is "wiser" than the other is unsubstantiated. Both models are faith based, and the model investor picks should match risk profile and timeline, and a mismatch there is not "wise".

Defining "enough" from risk/return perspective is just one of the ways and since I plan to cap my spending to SWR my "enough" is defined on the spending side which frees me to choose a portfolio matching my risk profile. My objective is to optimize returns to match the risk I am comfortable taking and deploy these funds on projects that is not related to lifestyle spending.

[Tyler9000]

The 1960s reference was from this chart.

http://www.crestmontresearch.com/docs/S ... -11x17.pdf

My point is simply that the OPs idea to put all of their money into a stock index fund may look fine in Firecalc looking backward, but doesn't account for the emotions associated with waiting 20 years for those safe-looking averages to manifest.

FWIW, I made no reference to the PP, and didn't claim investing in the stock market was unwise. I completely agree, in fact, that just putting your money in a savings account and counting on less than 3% returns is a bad idea. I only meant to offer some perspective on why some don't put all their money in stocks.

To each his own.

[Dragline]

I've seen that there are some people on this forum that appear to be highly risk averse, and are seeking less than 3% interest overall in their investing.

I'm concerned that there's a combination of math fail & lack of understanding of risk here. Also don't forget inflation is 2-3%!

There are riskier things to invest in with higher projected returns that the US equity market and/or leveraged ways to invest in that which would increase your potential gains. You should explore those if you are interested in maximizing potential returns.

And if you are not interested, you need to ask yourself why, given your thesis.

You might answer your own question in the process.

[Sclass]

Here is an engineering perspective.

I always thought the 3% figure was there to establish a factor of safety. A lower bound. Using FIRECALC for example you'll see if your money will last. I don't confuse this with how we actually get our money. I'd cry if I got 3% average. The number helps me do a sanity check on my withdrawal rate.

Pets.com never came back. Neither did Enron. How about Citigroup. What Ego said too.

James I hear what you're saying. When I first joined this forum I was surprised at what people were shooting for in returns. It reminded me of my coworkers (engineers) saying all they needed was $4 million in muni bonds and they'd be set. It was $4 million more than they had because they were trying to use vehicles like muni bonds to get to retirement. I never had the cruelty in me to tell them to give up and wait for Social Security unless they were ready to put some skin in the game.

But as time went by (I just passed my 2 yr anniv here) I realized this forum is more than just racking up high returns and saving away the money. It's about cutting waste, sustainable living, being creative and using that as a adjustable parameter to gain freedom or enter the investor class early etc.. It's about finding another way.

There are many knobs to adjust. Rate of return is one. I see the whole game like a time value of money relationship. You have present value, future value, time, rate of return and contribution. We need to work on all of them.

[Chad]

I'm not risk averse and I don't shoot for a 3% return. My goal is to significantly beat the average.

For instance, I have a much larger piece of my portfolio in emerging markets than is normally recommended. I am also actively trying to get some investments going in sub-Saharan Africa (not including South Africa), as these markets have the largest upside. Though, there aren't any good ETF's for this right now, but there are 2 or 3 in the pipeline.

I also believe that most diversification is only for those who don't really want to manage their money.

“Diversification is protection against ignorance. It makes little sense if you know what you are doing.” - Buffett

The market crashes like the internet bubble around 2000 and the 2007-2008 crash make me less concerned about risk.

I'm in the same position with my dad, as you are with your parents. He has a very large amount to invest, but is very risk averse with it. He didn't want to invest any in stocks, but I think I finally have him convinced to at least put 20-30% in good dividend paying stocks. The real problem is what to do with the other 70-80%. CD's pay nothing and bonds have a huge price risk in the current market. I think Exxon/dividend aristocrats are safer than bonds due to the interest rate risk, but it's hard to convince him of that.

[GandK]

@OP: Yes, I'm risk averse. I do not allow that fact to influence my investment strategy very much, as I'm only 40 and am aware of the effect of different rates of return on our family's financial plans. However, 30 years from now, I'm sure my investment strategy will more closely align with my natural preferences. And when that happens, some of my financial stress will diminish.

Western culture has made something of a cult out of emotions over the last 50 years or so... people are encouraged to consult their feelings before doing anything whatsoever, and a person's feelings are supposed to have the final say in every situation they face. Even as a Feeler that strikes me as silly. What I like and don't like has absolutely nothing to do with the math of strategic long-term financial planning. In fact, consulting my preferences would make for a very bad investment strategy in my case, since I tend to mourn loss more than I appreciate gain. Imagine the "strategy" that would result from that.

I agree with others that there's a difference - especially on this site - between the risk we are willing to take and the projections we make about future returns. I don't think you'd get a clear picture of the risk tolerance level of anyone here by looking at his projections or his desired SWR.

[Tyler9000]

I agree with others that there's a difference - especially on this site - between the risk we are willing to take and the projections we make about future returns. I don't think you'd get a clear picture of the risk tolerance level of anyone here by looking at his projections or his desired SWR.

This is a good point. I've often found myself assuming lower returns than the historical norm when I'm thinking about savings goal-setting and SWRs, even while that doesn't change my long-term investment strategy (and the reasonable associated risk). It's just how I temper expectations.

[JL13]

The 3% is an inflation-adjusted withdrawal rate, not an expected return. It's based on a couch potato 60/40 portfolio, using backtesting on firecalc.org. If you plug the numbers into firecalc you get 100% success rate and you'll notice that the average ending portfolio value is way way higher than the starting value. So yes, it's likely that we're going to end up much better than expected, but it's designed to be conservative to make the system robust.

The reason it's so conservative is
1.) it builds in a fail-safe - using 90 or 95% success rate for higher withdrawal rates would mean it would have a chance at failure.

2.) ERE assumes declining availability of natural resources which may make future growth rates worse than historical.

So it's an expect the best but plan for the worst situation. It's likely that most of us will end up very rich, but the extra conservatism will help if history doesn't repeat. It's win-win.

[jacob]

@JamesR -

Generally, the disagreement is not because of a difference in mathematical skills but due to a difference in how different investors define/see risk.

For example, efficient market/modern portfolio/"nobody can time the market"-theory investors tend to see risk as nothing but historical price volatility. The more volatile a security has been in the past, the more risk they assign. Since they also believe that such risk is rewarded, they believe that profit is determined by the reward of accepting volatility and that the more volatility one endures, the greater the returns.

Value investors see risk as the difference between the market price and the fundamental value they calculate. The more over/undervalued the market price is compared to the fundamental value, the more risk they assign. They believe that risk (as they see it) is punished. Like you said in another thread for housing, these people believe that the profit is determined by the price you pay when you buy.

There are many other ways of thinking about risk but these are the two dominant ones. They are often happily ignorant of each other. Furthermore, if they indeed remain happily ignorant of other viewpoints, they will happily take on huge risks as defined by other viewpoints while claiming that "nobody cares about that risk because 'nobody' knows".

PS: Another important aspect defining risk perception concerns how people's intellectual models/perceptions measure up against their personal experience. For example, it is very easy for someone who has only been investing for 5 years (since 2009) to see every pullback as an opportunity to "buy stock on sale" because all they've ever experienced with material amounts of money is large positive returns. Whereas it's much harder to for someone who had a large nest egg (corresponding to more than a dozen annual salaries) cut in half not just once but twice in less than a decade.

[JamesR]

Sorry for the late response folks.

elegant,

Since the SWR concept is based on 80% equity, and you are keeping it at 50%, technically your SWR is going to be closer to 4.5% than 3.5% based on the math.

But as time went by (I just passed my 2 yr anniv here) I realized this forum is more than just racking up high returns and saving away the money. It's about cutting waste, sustainable living, being creative and using that as a adjustable parameter to gain freedom or enter the investor class early etc.. It's about finding another way.

There are many knobs to adjust. Rate of return is one. I see the whole game like a time value of money relationship. You have present value, future value, time, rate of return and contribution. We need to work on all of them.

I have been here 1.5 years, and I do know it's about sustainable living, reducing waste/consumption, and being creative etc. That's precisely why we don't need to be overly risk averse, and can largely stick to 80% equity in index funds unless we want to invest more aggressively or start reducing risk profile after hitting 4% SWR.