Risk Happens

Risk Happens

While perusing the Bogleheads discussion forum, I recently ran across an interesting discussion about ways of taking on additional risk to increase expected returns. In short, the discussion-starter says that he’s socking away as much as he can in a fairly typical three-fund portfolio but that the expected 7-8% returns won’t get him to where he needs to be.

In hopes of increasing his odds of making it to the promised land, he wants to take on more risk but isn’t sure of the best way to do this. Suggestions included simply increasing his equity exposure at the expense of bonds or tilting his existing equity holdings toward small cap, value, and emerging markets.

Of course, there were also calls to earn more money (thereby enabling increased savings), work to a later age (increasing the nest egg and decreasing the years in retirement), or reduce his expected living standard (thereby decreasing the cost of living both now and in retirement).

Honestly, I have to say that I fall in with the latter group. One of the big things that people (especially younger investors) fail to recognize is that you can’t simply declare that you’re risk tolerant, then crank up the risk knob and enjoy fatter returns.

There’s a reason that increased risk is associated with increased rewards. For lack of a better phrase…

Sometimes risk happens.

And it can happen at the worst possible time. Yes, higher risk investments are typically associated with higher average rates of return. But we’re talking long-term averages here. And those higher averages come with higher (sometimes much higher) variances.

In other words, in the pursuit of higher returns, you could end up with much (much!) lower returns. Risk shouldn’t be viewed as some nebulous, intangible thing that you simply have to tolerate in order to crank up your returns.

If you have a long enough timeframe then yes, you can (hopefully) ride out the down times in hopes that things will recover before it’s too late. But there’s a very real possibility that things could turn out worse than expected so you need to keep that in mind when tweaking your asset allocation.

Look at it this way… If you can’t afford retirement on your current path, do you really want to stretch for higher returns? Sure, a fatter return could get you to where you need to be, but you could also wind up in an even worse position if things don’t go your way.

5 Responses to “Risk Happens”

  1. Anonymous

    Taking on too much risk is a sure fire way of getting your head handed to you. Unless you’re lucky you’ll face a situation where your retirement is going down the drain (likely when prices have bottomed) and bail out at exactly the wrong time. In the interim you’ve subjected yourself to unnecessary stress.

  2. Anonymous

    Stocks?! The clowns and crooks in the Wall Street Casino come after the horse track and Las Vegas. Stocks have heavily lost money over the last decade and are continuing to do so. I buy only corporate bonds at the niche between investment grade and not investment grade.
    Utilities such as Cincinnati Bell pay lower but may be considered safer.

  3. Anonymous

    I think a lot of people only look at the upside of risk then freak out when the downside happens. You really need to be able go wait it out or you’ll be in a much worse position.

  4. Anonymous

    Well said. When people shoot for higher returns, I’m not sure it really registers with them what risk really means: There’s a greater likelihood you’ll lose some or all of your investment, period. If every investment turned positive ‘in the long-run,’ then risk would be a function of age only.

    If I realized my retirement fund would be short at whatever age I expected to retire, the last thing I’d do is crank up risk. Doing so increases the probability of an even lower standard of living in retirement. Instead, I’d dial back risk and look for ways to boost income, cut expenses, now and in retirement.

  5. Anonymous

    I am turning 21 in a few months, and I’m a college student in the state of Iowa. I have been investing into the stock market for two years while trying to obtain 2 degrees. I have lost $2000 in the market so far, and I do connect with the post here.

    Do you think it’s to late for me to get back the $2000? Would it be okay just to be in bonds? I don’t know how I can move on, I am basically emotionally disturbed.

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