Risk aversion

[StressLess]

Hi All,

New to the site, finding it really amazing.  Have been doing my own version of the philosophy for a couple of years now, although not as disciplined as MMM and the rest.

Due to my natural tendency to save I have a strong aversion to risk.  Has anyone else battled themselves on risk aversion and thinking longterm?

At the current valuation levels and the recent bull market I've cut my exposure to equities because of the fear of loosing it.  I figure i had a good run from 2009 - now and couldnt stand the thought of loosing 20% -50 % in some kind of market crash/correction. 

[matchewed]

It's a fairly common question. Basically you're not battling risk aversion versus thinking long term, you're battling short term and long term thinking. You'll have to define for yourself what the money you plan to invest is for. Then make sure your thinking reflects that. If your money is for the rest of your life, then your investing should reflect that. Thinking in the now about the money for your future is bound to get you to make a mistake. It's much like how procrastinators end up feeling about their work. They can put it off in the now because the future can handle the consequences. Well the future when it comes to having to do the work ends up stressed and hamstrung. Don't be that way. Determine the use of the money and invest appropriately given your particular tolerance towards the risk.

Now that I'm mentioning the tolerance of the risk you do have an asset allocation right? You do know how volatile it is? What other risks may occur with that particular asset allocation? If not then I would say you don't necessarily have all the information to actually have a basis to worry. If you can't stand the thought of loosing 20%-50% at all, then you're in too much of an aggressive position for your tolerance. It's a trade off, either you get used to the thought or you reduce your risk and get used to the thought of lower returns. Pick your poison.

[Caoineag]

I have a risk I am averse to but its not the risk of a 50% drop, its the risk of slowly losing money over the long term due to inflation and lack of returns, aka I am not fond of leaving my money as cash. I would rather take a long term approach and lose 50% but then gain it back and then some then to just permanently, slowly lose the value of my cash. My challenge is how much cash should I keep on hand despite that so I don't have a liquidity problem.

That said, I never advise people to do as I do because each person is different. I know someone who refuses to invest in anything other than bond funds and an annuity but she also has rental properties. She has to do that to be able to sleep at night. There are risks to everything, you just have to determine which risks you can live with and which ones you want to avoid no matter the consequences. Just make sure you understand the consequences. Your particular risk aversion could keep you working for a very long time, mine could give me a cash flow issue at the wrong moment in time.

[Rika Non]

Music_Maker:

Are you still working?  For me the risk question relates more to cash flow.  While accumulating a stash, I embrace risk, since if I lose anything (or everything) it just means I work longer.  I know I have been able to earn that I have now, so I have no fear of having to do it over.  My other mental trick is just lots of diversification, I look at how many little slivers of a lot of different sectors I have and I remind myself that one industry's nightmare will be another's boon.

[hodedofome]

Charlie Munger has said if you can't stand losing 50 percent of your portfolio you shouldn't be investing in common stocks. It's happened to him twice in his lifetime.

[aj_yooper]

Have you read anything about the LP(Larry Portfolio: http://www.etf.com/sections/index-investor-corner/22204-swedroe-factor-tilts-of-larry-portfolio.html)?  It is a way of thinking about risk and return, which might help you figure out your best asset allocation.  For me, the amount of risk taken depends on your personal characteristics and where you are in the ages and stages of investing.  I am more to the low beta approach as I am retired and am not adding much to my portfolio now. 

[StressLess]

Thanks for all of the replies.  I do want to be able to hold 50% - 70% in stocks, but its hard for me to sleep at night when I've had that kind of allocation in the past.  Just wondering if anyone else has the same kind of fear?

I like the idea that I am battling long term vs short term thinking, need to think LONG TERM, too easy to see losses on day to day basis and get paranoid.

Yes still working, my wife and I are 30 and I are both maxing 401s and saving a good chunk of our income as well, so it's accumulating quickly and it's hard for me to justify the risk after factoring in what im getting from the employer match + tax savings (around 50%)

[matchewed]

Thanks for all of the replies.  I do want to be able to hold 50% - 70% in stocks, but its hard for me to sleep at night when I've had that kind of allocation in the past.  Just wondering if anyone else has the same kind of fear?

I like the idea that I am battling long term vs short term thinking, need to think LONG TERM, too easy to see losses on day to day basis and get paranoid.

Yes still working, my wife and I are 30 and I are both maxing 401s and saving a good chunk of our income as well, so it's accumulating quickly and it's hard for me to justify the risk after factoring in what im getting from the employer match + tax savings (around 50%)

Well we're kinda telling you about that "fear" as you put it. The best way to handle that fear is to find an Asset Allocation that fits your risk tolerance, understand the risks, write an Investment Policy Statement, and review it annually to ensure it meets your personal needs. If you have fears about and can't accept the risks associated with your particular asset allocation then it is not for you and you need to find a new asset allocation. If you just have fear but can accept it then it's no biggie right? Fear is not a good reason to take (or not take) an action.

[StressLess]

Thanks again.  Yeah, i think that my previous allocation was too aggressive for my liking 75% stocks to 25% bonds/cash.  I will re-evaluate my risk tolerance.   One thing I'm noticing, is that I was able to tolerate risk when the numbers were a lot smaller and I was just starting out 5 years ago!

[matchewed]

Thanks again.  Yeah, i think that my previous allocation was too aggressive for my liking 75% stocks to 25% bonds/cash.  I will re-evaluate my risk tolerance.   One thing I'm noticing, is that I was able to tolerate risk when the numbers were a lot smaller and I was just starting out 5 years ago!

That's normal. But you can use a bit of positivity to combat that. You have the saving skills and other lifestyle habits/skills to weather a bump in the road. And given the length of an average crash to recovery it is just a bump. Reevaluate your AA into something that let's you sleep at night and move on with the important stuff since you'll probably be okay.

[4n6]

Your aversion to risk isn't that unusual. Have you thought about investing in things that are less risky, but still exposes you to the market. What about balanced funds? I personally love balanced funds and have them as small portion of my overall investment portfolio. However, when I get closer to FI I plan on having about 1/3 in balanced funds. Fidelity Balanced, Vanguard Wellington, and Vanguard Wellesley Income might be worth investigating.

[Terrestrial]

Risk aversion is normal. NOBODY likes the thought that their portfolio could be worth 50% less next year.  The key to getting over it is twofold:

1 - Dont invest money you will need in the near term when said portfolio could possibly be down 30-50%.  With time you may even develop the stomach to look at this as a great opportunity to buy great investments on a huge discount.  The only time you will have actually lost any money is if you have to sell for some reason.  Otherwise, paper losses are just that...on paper.  None of us have any idea if the market will be 10% higher or 30% lower by this time next year.  To some extent the same is true for 5 years from now.  Most of us have a pretty good idea where the market will probably be 10, 15, 20 years from now.

2 - Realize that the 'risk' concept cuts both ways.  Not investing may keep you from having temporary paper losses that may result in anxiety, but it can also prevent you from having your portfolio grow...there is risk in that too.  You may not be outright 'losing' money but you certainly aren't making it, and all the while the buying power of your non-invested money is eroding, opportunity cost of not being invested is a form of risk too.

[StressLess]

Thanks guys.

Your aversion to risk isn't that unusual. Have you thought about investing in things that are less risky, but still exposes you to the market. What about balanced funds? I personally love balanced funds and have them as small portion of my overall investment portfolio. However, when I get closer to FI I plan on having about 1/3 in balanced funds. Fidelity Balanced, Vanguard Wellington, and Vanguard Wellesley Income might be worth investigating.

yeah absolutely.  we are actually DCA into both wellington and wellesley in our rolled over IRA.  Unfortunately most of our sheltered money is with current employes 401s that dont offer those.

Risk aversion is normal. NOBODY likes the thought that their portfolio could be worth 50% less next year.  The key to getting over it is twofold:

1 - Dont invest money you will need in the near term when said portfolio could possibly be down 30-50%.  With time you may even develop the stomach to look at this as a great opportunity to buy great investments on a huge discount.  The only time you will have actually lost any money is if you have to sell for some reason.  Otherwise, paper losses are just that...on paper.  None of us have any idea if the market will be 10% higher or 30% lower by this time next year.  To some extent the same is true for 5 years from now.  Most of us have a pretty good idea where the market will probably be 10, 15, 20 years from now.

2 - Realize that the 'risk' concept cuts both ways.  Not investing may keep you from having temporary paper losses that may result in anxiety, but it can also prevent you from having your portfolio grow...there is risk in that too.  You may not be outright 'losing' money but you certainly aren't making it, and all the while the buying power of your non-invested money is eroding, opportunity cost of not being invested is a form of risk too.

yeah, our emergency fund (1 year worth) is in ally high yield savings account.  Thanks for the insight on risk, we are making about 1.8% on the money moved over from equities in a fixed income option.  not great, but not terrible while i plan for a more comfortable asset allocation for my risk tolerance.

thanks again all!

[Le Barbu]

I would never go under 20% equity exposure. Anything between 20 & 50% will perform decently while being pretty strong. Match the equities with bons and TIPS and you're set !

[mak]

Some losses do not come back, they become permanent.  I have had many individual investments go to zero, bankruptcies, delisted, loans gone bad, fraud, etc.  Also losses as a % of total diverisfied portfolio (say 57% peak to trough on S&P) may look tolerable when the portfolio is 1x-5x annual expenses, you are young, working, and accumulating.    What if portfolio is 150x annual expenses?  a 50% drop means you sit there and see you have lost 75 years of your living expenses.  And you need to take xanax and totally cannot sleep. 

I have had a lunch once and exited a restaurant to find I had lost 3 years of living expenses on paper during an hour.  During the ensuing week I lost another 10 years of living expenses on paper.  When I consider I am sacrificing so much to be frugal, working so hard to keep those living expenses down, not buying the pretty BMW, then see a couple of new BMW's being taken in a few hours by volatility (even if it may come back later, a year, many years, after I'm dead who knows), the whole exercise seems too much.  Sacrificing so much for what? 

I think risk (volatility) needs to be considered not just as % of portfolio, but as % of living expenses, just saying. 

[aj_yooper]

+1 mak!  Excellent points on risk as it relates to ages and stages of investing and points on whether one should own individual stocks or even bonds.  It is easier to be pedal to the metal when one is starting to accumulate, but when you approach some investment milestones, I think, it makes sense to cover your nut and take risks on a smaller portion of the assets.

[LordSquidworth]

Thanks for all of the replies.  I do want to be able to hold 50% - 70% in stocks, but its hard for me to sleep at night when I've had that kind of allocation in the past.  Just wondering if anyone else has the same kind of fear?

I like the idea that I am battling long term vs short term thinking, need to think LONG TERM, too easy to see losses on day to day basis and get paranoid.

Yes still working, my wife and I are 30 and I are both maxing 401s and saving a good chunk of our income as well, so it's accumulating quickly and it's hard for me to justify the risk after factoring in what im getting from the employer match + tax savings (around 50%)

Then stop looking at it everyday.

Stick to looking at it quarterly, if not less.

You're both 30 so you're looking at a time horizon of probably another 30 years. My portfolio is probably far riskier than the majority of posters here, and I don't have the need to check prices that often. Markets down 170 points right now today. Am I flinching? Not in the slightest.

[RapmasterD]

Thanks for all of the replies.  I do want to be able to hold 50% - 70% in stocks, but its hard for me to sleep at night when I've had that kind of allocation in the past.  Just wondering if anyone else has the same kind of fear?

I like the idea that I am battling long term vs short term thinking, need to think LONG TERM, too easy to see losses on day to day basis and get paranoid.

Yes still working, my wife and I are 30 and I are both maxing 401s and saving a good chunk of our income as well, so it's accumulating quickly and it's hard for me to justify the risk after factoring in what im getting from the employer match + tax savings (around 50%)

Then stop looking at it everyday.

Stick to looking at it quarterly, if not less.

You're both 30 so you're looking at a time horizon of probably another 30 years. My portfolio is probably far riskier than the majority of posters here, and I don't have the need to check prices that often. Markets down 170 points right now today. Am I flinching? Not in the slightest.

He is LORD for good reason. Read his post three times out loud and again....YOU ARE 30!! I'm 52, am in 80%, and am not flinching one bit. I actually know I have at LEAST a 30 year horizon.