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The Risk of Not Taking Risks

May 17, 2013

Today, Brian and Bo tackle the risk that you take by sitting on the investment sidelines.  They have been fielding a number of questions over the past few months covering this very topic.  The moral of this episode is to get started doing something sooner rather than later so that you do not miss out on what the market has to offer.

Brian shared an interesting piece of data that showed if you invested $10,000 a year for 25 years during the period from September 1, 1929 to September 1, 1954 (the Great Depression), while the DOW only increased 2 points in overall value (381 to 383), your dollar-cost-averaged investment would be worth $1.5 million.  This shows that during a period where the market did not really appreciate at all, there was still value in investing your money in the market.  That equates to an annualized return of 11.7%.

So, with that information, there are a few factors that need to be considered:

  1. Do you have enough cash to cover your emergencies?  You should maintain enough cash reserves to replace at least 3 to 6 months of your income.
  2. What is your monetary needs timeline?   If a big purchase is on the agenda, it may be necessary to hold that money in cash to avoid losing substantial amounts of the principle (down payment on a house 3 to 4 years from now).
  3. Make sure that the cash you are holding in the bank does not exceed the FDIC insured amount of $250,000.
  4. Measure your risk profile:
    • Risk vs. Reward: How much risk are you willing to take for your desired level of returns?
    • Risk Tolerance: Correlates with your risk vs. reward by measuring how much risk you can handle for a given amount of reward (or loss).
    • Risk Capacity: How capable is your portfolio of taking loss given your investment timeline?

Risk of Not Taking Risk:

Inflation risk: Inflation could be a factor in the near future, is your portfolio giving you the required appreciation to maintain your purchasing power?   Ask yourself what one dollar today will buy for you in 10 years.

Outliving your money:  If you and your spouse reach the age 65, there is a 50% chance that one of you will live past age 90.

Multi-Generational Housing: Beware of running out of money and having to move in with your children (not because you want to, but, because you have to).  Make sure your army of dollars is working for you!

Strategies to combat the fear of uncertainty:

  1. Have ample cash reserves worth 3-6 months of salary.
  2. Diversify your allocations: cuts volatility, use alternatives to outweigh individual sector risk, it has psychological value.
  3. Dollar cost averaging: This is something we preach! Spread your purchases out over time to help mitigate risk.

Things to consider when entering the market:

  1. When do you want to retire?
  2. How much money do you want every year in retirement?
  3. Do you want to leave a legacy?

 

Interesting Facts:

–          If inflation averaged 3% per year over a 25 year period it would cut your purchasing power in half!

–          Current S&P 500 dividend yield is greater than a 10 year treasury bond.

 

 

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