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When Risk Becomes the Focus
To often, risk is thought of in the wrong way. The wrong way? When markets move up one day almost vertically, and then down another, almost vertically, how can I say that risk isn't present? How can I say that risk is something you should keep an eye on, but should not be your focus?
But risk is not about volatility. Risk is about reward.
Okay, I know exactly what you are saying. My wife looks at me quizzically each time I tell her to send X amount of dollars here, or X amount there. But those funds are losing ground, she replies. "Aren't we throwing good money after bad?"
You have got to look at the big picture. The really big picture.
You can expect to live longer than your parents. That fact alone allows you the ability to ignore short term risk, which is what the market has been going through for the past 24 months, and focus on the long term gains that are part of a portfolio that has some risk. I have, in the past asked each of you to assess your ability to withstand risk. What I should have asked you is: "what would happen to your plans, if you took the safe road, avoided risk as much as possible, and lived a really long time?" If I had asked that, I would have been inclined to answer it for you. You will outlive your money.
Risk involves an examination of your saving patterns, a close look at how you spend your "spendable" cash, inflation and what it will be down the road, what you think the market will return, and how long do you plan on living.
In the roughest example possible, we will look at your portfolio by looking backwards. Suppose you retire with a million bucks, saved and scrimped, and are looking forward to a forty year life span in retirement. Suppose you retired in 1960, and suppose we calculate that from then to now. Suppose you want to draw a cool 40 grand per year as income.
Suppose we also took that entire portfolio and dropped into a bond fund, indexed for the total market. Because inflation climbed quite high during the early sixties and as a consequence, the bond market stumbled, your time horizon for your money was nearly halved. After 19 years or so, you would be looking to move in with your kids, penniless. Of course that would reflect a worse case scenario. In the early eighties, bonds were doing much better, but the lack of risk exposure took the total portfolio value down to a little over a quarter of a million dollars after 40 years. This type of investment style is the least risky in terms of short term loss. What it did though was create the highest possible atmosphere for short term risk.
Suppose you took the same amount and invested in a 50/50 split between bonds and stocks. This type of portfolio, indexed also for low expenses, would allow you a few more years in the worst case, and would probably see you outliving your money in the best case. I should mention that in each of these cases, the amount your are willing to live on as income greatly effects the ending dollar amount. Live on less per year, and your money will last longer. The same goes for the investor who put their money in a 100% stock portfolio with the highest risk of short term loss, but also the lowest level of short term risk. Retiring with that kind of plan will allow you to outlive your cash on average.
It boils down to the plan. If you are prudent, save, and spend only what you need, you will probably beat the risk and outlive the odds against you. If you continue to seek out the lowest possible cost on your investments, you will add precious years to the balance of your portfolio.
It is important to remember that volatility tells us nothing about risk, amounting to a statistic that is more probability than fact. The real risk, according to Robert Jeffery is "in holding a portfolio that might not provide its owner...with the cash he requires to make essential outlays."
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