Risk tolerance is a funny thing. Most people think they have a higher risk tolerance than they really do. But the reality is, only when you are losing a lot of money do you finally realize what your risk tolerance truly is.
I'd like to think that I'd be able to stay the course and go all-in during a stock market downturn like everybody I meet on the internet, but I'd be lying to myself.
With emotions and people depending on you to survive, your risk tolerance likely isn't as high as you think it is. Just like how your net worth is an illusion, so is your risk tolerance.
Whatever you think your risk tolerance is, temper it by at least 20% to get your true risk tolerance. This means carefully reviewing your portfolio and reducing exposure to some of your riskiest names by 20% or more, especially if you're up a lot.
My History With Risk Tolerance
Experiencing rapid losses in 2000 as a 23-year-old freaked me out. Therefore, I sold all my after-tax internet and tech stocks within two months after the downturn began because I was losing roughly $5,000 a week.
In the end, I lost about 10% from the peak. If I hadn't sold, I would have lost around 65% over a two year time period. What's worse, I would have had to wait until Aug 1, 2013 to get back to even! Can you imagine sitting on dead money for 13 years?
Between 2000 – 2013 I continued to max out my 401(k) and buy stocks. But I didn't have the foresight to go all-in on August 1, 2002 when the NASDAQ bottomed. Instead, I mostly hoarded cash and bought 4.5% yielding CDs as I moved from NYC to San Francisco in 2001. The last people to join a company tend to be the first to let go.
Seeing how violently stocks corrected between 2000 – 2002 made me gun shy to ever bet the farm again. Instead, I bought San Francisco property in 2003, 2005, 2007 (Tahoe, oops), 2014, 2019, 2020, and 2023 because it felt so much better to have a physical asset instead of a paper asset.
For thoroughness, I also sold my largest rental property in 2017 when my son was born because I needed to simplify as a first time dad.
Missed Opportunity To Buy During The Financial Crisis
After the financial crisis of 2008 – 2009, I again didn't step up to the plate and buy large amounts of stock or property between 2008 – 2011. All I did was continue to max out my 401(k) and make sure I didn't get laid off.
I became disillusioned with the financial services industry and wanted out. Therefore, I ended up hoarding more cash to give me options just in case I decided to take a leap of faith, which I did.
It wasn't until August, 2012 that I bought 12X more stock than my normal cadence due to negotiating a six-figure severance package. I viewed my severance as the house's money, so I figured why not risk it all in the S&P 500 and see if I could make more in the future. With my non-severance cash flow, I remained conservative.
Despite feeling like we were out of the woods by 2014, I still couldn't invest aggressively in the stock market. I was again fearful of losing money.
Instead, I decided to buy a SF fixer in 2014 because it felt like there was some serious mispricing of SF ocean view property. But the other reason why I bought was because I wanted to reduce my housing expense by renting out my old place.
Still Cautious Today Given I Have A Family To Care For
After selling a SF rental home in the summer of 2017 in order to simplify life, I decided to invest ~$1.2M of the ~$1.8M net proceeds in stocks and bonds. I had already taken risk exposure down by $800,000 by getting rid of the mortgage.
I told myself that my risk tolerance was being able to lose about 10% before worrying, so I invested in roughly 60% stocks / 40% municipal bonds.
Everything had been going pretty well since August 2017 when I first opened up the account. Then February and March 2018 beat me up.
Even though I “only” lost $22,968.82 in February and $25,361.72 in March (-1.7%), there was a time in February where I was down around $50,000 (-3.4%). That's when I started to feel uncomfortable.
February was a month that had a violent drop and then recovery. But March ended the month at a low. See the chart below.
Losing $50,000 in a couple weeks in just one out of eight investment accounts I track on Personal Capital made me seriously reassess my risk tolerance.
When I was down $50,000, I became demotivated to do any work. For example, being offered $1,000 to sponsor a podcast episode just made me depressed because it let me know I'd have to put in serious hours to recoup all my losses.
I also wanted to start spending money on something before the stock market took all my capital away. Heck, $50,000 could pay for a year's worth of college tuition or really help the foster center I was volunteering at.
A good-enough investor understands his or her risk tolerance. Further, a good-enough investor doesn't let investment losses or wins wildly swing their moods.
Losses Affect My Mood Too Much
One of the biggest reasons why I don't like investing a majority of my capital in public stocks is due to volatility. When I see stocks plummet due to whatever reason, my mood sours. When my mood sours, it negatively affects my relationships. As a result, I've kept publicly traded stocks to at most 35% of my net worth since retiring in 2012.
Physical real estate accounts for about 50% of my net worth today. Although real estate takes energy and time to manage, I find solace knowing that real estate provides shelter, generates income, and is a tangible asset that doesn't just lose lots of value overnight.
In fact, post-pandemic, the value of all real estate has increased permanently due to more people working from home. In addition, with the real estate commission price fixing settlement, homeowners should see a 1% – 4% boost in their holdings.
Once I reached my limit in stocks and physical real estate, I began building a decent position in private real estate funds. They provide real estate exposure with zero hassle.
What I realized after reviewing my private real estate funds dashboard is that I really don't like volatility. It's nice to see my stock and bond account go up, but the feeling of loss is at least 2X worse than the feeling of joy when I make money.
Instead, I'd much rather have a very stable capital account with a monthly dividend payment so I can focus on writing and spending time with family. During downturns especially, cash flow is more important than net worth.
Here's hoping my real estate crowdfunded investments do indeed return 10% – 12% a year for five years. But with COVID-19 upending commercial real estate like office and hotels, things are going to probably be dicey for a while.
Don't Overestimate Your Risk Tolerance
Look, I know it's easy to feel like an investing guru in a bull market. Especially if you only started investing a significant amount of capital since the financial crisis. But trust me when I tell you that your confidence to “stay the course” and “buy when there's blood on the streets” is misguided. Your true investment risk profile is unknown until you lose a lot of money, twice.
When there is blood on the streets, you will be worried about losing your job or your customers. If you have leverage due to a mortgage, your equity will get zapped away. You will logically go into survival mode and start preserving capital to protect yourself from misfortune.
During a recession, maxing out your 401(k) or IRA, pre-tax retirement accounts you can't touch without a penalty until 59.5 is easy. This is where everybody needs to stay the course. It's taking a step beyond and risking significant amounts of capital in your after-tax investment accounts when the markets are going down every day that is extremely hard.
Maybe everything is relative, and those telling me to “stay the course” are simply maxing out their 401(k)'s to the tune of $18,500 a year and not referring to investing multiple times extra in after-tax investment accounts. No matter. Right now, I fear having to go back to work full-time to provide for my family more than anything else.
As a result, I'm trying to reduce my risk exposure given stock market valuations are so high after an incredible run since the pandemic began.
Here is a post on how to have a risk-appropriate asset allocation when investing. Corrections and bear markets are a part of investing. The key is to keep on dollar-cost averaging during downturns.
Evaluating Your Risk Tolerance
Here are some questions you should ask yourself to discover your risk tolerance.
- What percentage of your annual salary or annual expenses are you willing to lose before you start getting extremely uncomfortable? My answer: six months worth of expenses.
- How much longer are you willing to work to make up for any large losses? Using Financial SEER is one of the best ways to quantify risk tolerance through time. My answer: three months.
- How much time are you willing to spend away from your family? My answer: no more than three days a year for the first five years.
- Have you been laid off before? If so, chances are higher than average you will be laid off again during the next recession. My answer: yes, but on my terms with a severance.
- How much in after-tax capital did you put to work during the 2000 and 2008 financial meltdowns? My answer: not much at all besides maxing out my 401(k).
- Did your losses in 2008-2009 equate to more than a year's salary? My answer: yes, many years worth.
- If you lose your job and 40% of your investable assets, do you have enough liquidity and alternative income streams to hold you over for at least a year? My answer: yes, although my alternative income streams will likely decline.
- Does your mood tend to follow the market's ups and downs? My answer: there is a stronger correlation on the downside.
- Do you confuse brains with a bull market? My answer: all the time.
- Are you uncertain about an investment? Then go halfsies. This way, you are acting congruently with your uncertainty.
Whatever you think your risk tolerance is, take it down by 50% and that is more likely your real risk tolerance. Being overly confident is extremely dangerous when it comes to investing.
Managing Risk Tolerance
For me, my ideal financial scenario in retirement is stability and conservative returns. Investing a minority portion of my investments in growth stocks to combat investing FOMO is fine. However, once you've reached a point where you have enough capital, it's worth dialing back risk.
My main focus is on generating as much stable passive income as possible so my wife and I don't have to go back to work. After a scary March 2020, I'm focused on real estate instead of stocks as a more stable investment.
At some point, you will have amassed enough capital where you never have to work again. The key is to preserve your capital while also getting it to work as hard for you as possible.
With so much strength in the markets since the pandemic began, investors' risk tolerance has likely gone up. However, it is during good times when I encourage all investors to be the most cautious.
Think back to 2006-2007 when investors though they couldn't lose. Just one or two years later, investors lost big time. The number one rule of financial independence is to never lose money. Always be making financial progress so you can live the life that you want.
Manage Your Risk Exposure Online
Sign up for Empower, the web’s #1 free wealth management tool to get a better handle on your finances. Their award-winning Investment Checkup tool gives you a fantastic overview of your risk-exposure.
From there, it's much easier to see where you need to add and reduce positions to better manage your investments. Because I have eight different portfolios, I often times underestimate how large my positions are until Empower gives me an overview.
After you link all your accounts, use their Retirement Planning calculator that pulls your real data to give you as pure an estimation of your financial future as possible using Monte Carlo simulation algorithms. Definitely run your numbers to see how you’re doing.
I’ve been using Empower since 2012 and have seen my net worth skyrocket during this time thanks to better money management.
Diversify Your Investments With Real Estate
Real estate is my favorite way to achieving financial freedom because it is a tangible asset that is less volatile, provides utility, and generates income. Stocks are fine, but stock yields are low and stocks are much more volatile.
Given interest rates have come way down, the value of rental income has gone way up. The reason why is because it now takes a lot more capital to generate the same amount of risk-adjusted income. Yet, real estate prices have not reflected this reality yet, hence the opportunity.
Take a look at these two real estate private investing platforms.
Fundrise: A way for accredited and non-accredited investors to diversify into real estate through private eFunds. Fundrise has been around since 2012 and now manages over $3.2 billion for over 350,000 investors. The Fundrise funds predominantly invest in residential properties in the Sunbelt region, where yields are higher and valuations are lower.
CrowdStreet: A way for accredited investors to invest in individual real estate opportunities mostly in 18-hour cities. 18-hour cities are secondary cities with lower valuations, higher rental yields, and potentially higher growth due to job growth and demographic trends. It's important to do your due diligence on the sponsor and the deal before making each investment. If you have enough capital, you can build your own select real estate portfolio with CrowdStreet.
I've personally invested $954,000 in real estate crowdfunding across 18 projects to take advantage of lower valuations in the heartland of America. It's wonderful to receive real estate capital distributions years after investing. You almost forget that you invested a sum of money years ago because you're not constantly reminded about the investment's latest values. The longer you can stay invested, usually, the better the returns.
Both platforms are long-time sponsors of Financial Samurai and Financial Samurai is a six-figure investor in Fundrise.
Hi Sam,
My Wife the GYN heard in 2000 to 2012 the main medical problem of many women.
“My husband lost all the money in the stock market”.
My wife was concerned about Y2K so we moved to bonds in 1999 except the DRIPS.
We moved to bonds in 2007 because I wanted to test a retirement portfolio.
This was to plan for 30 years of service in 2011 .
After the dip retuned to 50% stocks and 50% bonds.
Family members would ask my Wife in 2003 and 2009 if we lost money?
Our money grew in value during the dips.
These last 3 years the bonds in portfolio are down 3-4% but monthly payments continue.
We retired in Fall 2015 leaving again in May for 3 months of scuba Waikoloa Beach, Hawaii.
All the best ! Steve
I went through 2008 with a 40% plus by sitting put. Banks went down, but FAANGs revovered significantly two years after.
Congrats. Are you retired now as a result? 16 years and so much gains later.
I stopped working with 43. Now I am 65. The crisis of 2008 hit me in a hotel room in Kathmandu. I became depressed and got drunk on local booze, raised myself from the dead next morning with a heavy head and went for a spiritual uplifting to a temple, next then into a cyber cafe. I had a blog in My Space going and declared, that I will simply sit this manipulated crisis out. I also predicted that by 2010 most stocks would be higher then before the crisis. So it came to be.
Sounds great! Any regrets? What would you have done differently if you could rewind back to 43? I’m 46 years old now and can use all the wisdom I can find.
Any kids?
Hi,
I love this article and have read it several times. I want to ask about a point though, in your spread sheet the two month loss equates -48k approx whilst the proceeding two month gain was +56k
No one has pointed this out. What are your thoughts?
In 2008 S&P went down ~40% http://people.stern.nyu.edu/adamodar/New_Home_Page/datafile/histretSP.html
Very few people could stand that kind of drop. I was one of them – moved ~50% of our portfolio to bonds and didn’t switch back to stocks until 2010? Later my friend, a hedge fund manager told me something similar to Taleb’s Barbell Strategy (although he didn’t know at that time): keep a few years living expense in cash, the rest in S&P. During the downturn, he didn’t switch to bond, instead he switched some of his weak stocks to strong stocks that got punished unduly and stayed invested.
Since then we’ve been maintaining a similar strategy: we have real-estate portfolio that generate positive cash flow that can supply our basis need (like tax, food, transportation, etc..) and if we cut out trips to exotic locations or expensive restaurants, etc.. plus a few months worth of cash. The rest we keep 100% in S&P. The plan is never to touch S&P and can reap the long term benefits (~8% yoy w/ dividend-reinvest).
We don’t know how this would work out in the next crash, but will keep adding to cash from now on since we’re quite nervous too.
Sam, you just gotta chill out and ride the waves. at the end of the day it’s only money. health and family are worth much more. If a loved one gets sick, has cancer or Alzheimier’s, all the money won’t help much.
You haven’t actually lost money until you sell your entire position and cash out.
If you are that worried just liquidate everything and buy 2% gov bonds.
About time and money, if someone offered to give you 10 extra years of life in exchange for all your money now would you do it?
You’re absolutely right. It’s just money, which is why I decided to leave work at 34 and enjoy life. It’s been so awesome, especially now that I have a baby boy 10 care of. It’s a great blessing.
At what age did you decide to do your own thing? What’s your background?
I’ve got a business degree and did marketing and finance work. Then had enough and started doing things I like and not chasing jobs with bigger income.
I’m Chinese as well, raised in North America. Parents 1st gen immigrants. Asian culture seems to be too fixated on money and not emotional well-being.
See it alot in my city, kids driving Ferraris, top end BMW’s Mercs. Dad made all the money in China. It wouldn’t turn out well when they grow up.
I’m around your age and decided a decade ago to stop worrying. Could have stayed in my cushy government job with pension but life is too short for that.
Cool. So what is it that you do now?
Let’s just say I get to travel and live on my clients’ expense in interesting countries. All because I speak English and Mandarin and they need it.
There is a huge interest in Chinese now, you got Mark Zuckerberg and tons of foreigners learning because they see China as the next big global market.
How’s your putonghua these days?
You could probably live like a king if you move to Shenzhen or that area. San Franc’s too nice to give up though I get it.
What are the money-making options of being bilingual, other than being an English teacher in China?
I also know Chinese reasonably well. I have a PhD in Electrical Engineering, and have been a hedge fund manager for my own fund. Would like to know what the money making opportunities in Shenzhen as well.
Hi Financial Samurai, been lurking for a while, discovered you through monevator, I appreciate your content and find it interesting, thank you
Am I right in thinking that for you, losing money feels like something that potentially might not recover? And feels not as a % but a scary $ amount?. I perhaps shouldn’t but try to maintain a faith in the markets that has made it easier, I fear inflation more than volatility because I’m young, I have a long time horizon to wait things out, hopefully the discipline. I hope to attain security by growing beyond what I could ever need rather than protecting what I have.
I’m a fan of compartmentalising assets, there’s a certain amount I need to be safe and a certain amount to play with
Nice to hear from you. My biggest fear is Losing time, which is the result of losing money. I know there’s a great chance I’ll recover from a correction, but it takes time. Now that I’m older, I really don’t want to wait 10 years to get back to even like many did in 2000.
Thank you for your time in responding, by the way
Time as in early retirement, I get that, maybe an annuity gives a guarantee of that? Although in America i don’t know if you have something equivalent to fscs protection – for us annuities (as insurance) are 90% protected with no upper limit
I worry about counterparty risk mostly, as there was a case over here where “ring fenced” funds were still raised to pay for the (very expensive) distribution of funds, and we are only covered up to £50k per custodian here, but also more people are running multiple checking accounts after 2008 and the recent TSB bank computer failures, so that we can still pay bills
Anyway, I wonder what your eventual goal is? I would like to leave an inheritance and wish to transfer assets “in specie” so it doesn’t matter if I die in a market crash, also i just invest for sport, and because I believe capitalism has the power to do good by providing liquidity on the secondary market so that companies can grow when they do issue new shares. I believe that the wealth we produce is a function of the good we do society, and I believe that “public good” of capitalism can come as much in the cheap supply of socks and food as it does new technology
The real question is, “When do you need to sell?”
That will determine your acceptable risk tolerance.
Short term: Lower risk/volatility, Time is against you.
Long term: Higher risk/volatility, Time is on your side.
Example: If an asset such as a 401K is needed in 20+ years, then the risk tolerance should be high. If the market corrects, the sky is not falling since time is on your side to weather the downturn. As you get closer to your sell date, reduce the risk/volatility with more stable assets.
Hi Sam, long time reader, big time fan, and first time posting.
in your opinion, what is the safest short to mid term asset to park investments right now?
My situation is that i have 70% of my net worth becoming cash in next 6 months, due to business sale. Will need to put that cash to work, because i do want to retire early, but of course worried about possible down-cycle.
thanks and congrats on a high quality blog!
Victor
Safest would be an online FDIC-insured money market account paying a high yield. You can just park the money in a CIT Bank money market account or short-term CD for example.
Related: Ranking The Best Passive Income Investments
I started off on a similar path Samurai. I invested in blue chip stocks when I was in my early 20’s based on expert/friends opinions. I knew I was going to be a millionaire, so I did with with all the confidence in the world. 12 years later, I was still down 40% and eventually sold them all for a good loss. Now, a few years on, I spread the risk between investment properties, indexed funds & a few side gigs. We are never out of the eye of risk but we can only protect as much as we can.
I have massive tolerance for risk and would not be affected much even if i were lose 50% or more. I went through 2 recessions, 2001 and 2008. I lost a 90% of my money and vowed never to invest again. But then I saw the recovery and decided to wait for the next recession. My wife and I started 401k in 2009. I bought my primary home and investment properties in silicon valley from 2009 to 2013. I have stopped making any additional investments (except for full 401ks) since 2017 and have been concentrating on paying down debt. Have also lined up 500k line of credit in case there is a recession and market tanks. This coming recession I will be going all in, guns blazing… I hope I am able to muster the courage to do it like I did in 2009!
Separating your own money into house money and your truly yours money seems l me an illusion too.
Also, reallocating your assets to safer bonds, CDs or even cash and gold is actually a lot easier to do in a 401k because there are no tax implications. If I want to rebalance I always first try to do a total asset rebalancing by doing as many transactions as I can inside my 401k. Outside the 401k a lot of other considerations, mostly taxes, come to play. Especially when you are already stressed out due to a quickly moving downturn or are experiencing FOMO anxiety in a quick upturn, the complication of taxes is the last additional thing you want to think about.
I’m not that afraid of losing 30% even if I have to wait for a decade to recover (I can say that having battle tested myself in 2000 and 2008 where I was down 1M — and already out of the workforce since the early 2000s.
What I’m afraid of is the -30% being just the first installment of the black swan event where assets disappear to never recover again, as in prewar Europe or early 90s Japan. THAT is what makes you think of selling at a -30% loss, not the red numbers in parentheses on your monthly statement. At the end of the probability tail that wolf will one day come. Americans seem to have never experienced it so they are a little naive about it.
Think of how you would feel if all your assets were in a defaulting bond where you got paid 45% after the bankruptcy haircut. That to me is the ultimate test of your risk tolerance. And somewhere at the end of the probability tail this event DOES exist — even for Americans.
In the thirties Germany was a civilized country. And many of my ancestors thought “have faith, things can only get this bad, we’ll bounce back…”. They are not here to tell us about the losing end of that hopeful confidence.
Self righteous pitchforks can get nasty. Really nasty. In the financial world, as voters keep voting themselves ever more goodies from the common tax trough, a runaway bankruptcy is not out of the question. In that scenario, investors (i.e. people who engaged in delayed gratification in exchange for a promise written on a piece of paper (stock, bond etc) will be the easiest targets (ducks sitting on a piece of paper) for the once goodie voting citizens (the very instigators of the crisis) now turned angry pitchforkers.
Sometimes things turn out really unfair, and one has to keep an eye on the horizon. Most are just storm clouds, but once in a while they’re the harbinger of a category five hurricane.
Well said. How are you investing your money and spending your money at this time?
Given you’ve had a long history already, how do you figure out how much to spend and how much to leave behind? Is it hard to spend down your funds?
I don’t try to time the market. My only deviation from looking at the stock market as a random process is long term economic growth.
National economic growth is the wellspring of all gains. And looking at the past few decades the US is no longer a growth leader in the world (the growth trendline is just about half the world average ) and Europe is the slowest growing continent on earth. For most of its history the US had a growth rate much higher than the world average — and that is how Americans climbed to the top of the worldwide prosperity rankings (there is no other way, really). That is no longer the case. Total human growth has picked up pace in the last three decades and the US has not kept up, with US growth trendlines now being close to half the world average. Europe is even worse, and thus in an even faster decline. I think that the US government has grown too big, consuming close to 40% of GDP, approaching European levels, and so economic growth is closer to the dismal European levels, way below world average, and thus an arithmetically deterministic path to decline, as compounding dictates (I don’t feel I have to explain that in investing circles). I don’t see that trend reversing any time soon in the developed democracies, as voters seem to be addicted and essentially deadlocked into voting themselves ever more goodies from the common tax trough, and Europe quickly fading away on the world stage in two-three more decades, the US following with some delay. With a growth rate below world average, nothing is sustainable — nothing.
Because I don’t try to time the market all my moves tend to be slow and time averaged. I’m now gradually moving away from stocks and investing in real estate, but not in highly leveraged coastal areas. I prefer areas where valuations are not more than 2x construction costs. That is where US real estate is really cheap by world standards.
I’m also investing a bit into countries with strong economic growth. As risky and as susceptible to immediate crashes these markets may be, I think they will still provide superior long term results, by virtue of their faster economic growth and the relative stagnation of advanced democracies. I’m 10% into diversified emerging markets and slowly increasing. I’m not sure at what percentage I’ll start feeling uncomfortable. Strong dollar and uncertainty may indicate a good (cheaper) time to buy, or be the harbinger of a deep impending trough, and who knows maybe a spectacular recovery in ten years. As I said, I don’t time the markets, I just look at long term trends because my investing approach is now turning intergenerational. I see my investments through the eyes and life expectancies of my children.
BTW, a related question. Do you think that the first person to live five centuries through fundamental genetic in-vivo interventions is already alive? That would change some investment considerations and strategies, wouldn’t it?
Forgot the remainder of your question: I’ll leave behind as much as I can without having to go back to work, though there have been years where through consulting arrangements I got suckered back to work. I eventually slap myself in the face and quit again.
My funds have been increasing, covering expenses and then some for two main reasons. First I have found the 80-90k spending level being ideal in a non coastal area. In economic terms, for me, marginal happiness drops very fast with income past that stage (*) and
Second, my funds and real estate have had a pretty good long term averaged run, but that only because the veal black swan has not come yet. Will it come? When? Who knows? It’s good to keep it in mind as a possible scenario but you cannot live in fear.
(*)BTW, I have many friends, some very competent and smart who also feel the same decreasing marginal utility of money past the 90k/year expense point. We could actually form a 90k club. They too called it quits when they hit the safe 90k mark. And that is why it is very hard to keep competent people employed. There are many-many people out there who could have gotten to 300k annual W2 earnings, yet when that is combined with taxes (and the threat of estate taxes) they just called it quits early. The lost economic vitality is enormous, and in my view one of the main reasons behind the subpar performance of the US growth rate compared to the world average. In Europe they don’t even get to that stage as significantly higher taxes and more free unconditional services at the bottom of the income scale create such a flat effort-reward curve that most Europeans stay with mediocre ambitions at a daily job and never get to a position of being financially independent, in spite of being better educated than most of their American counterparts. Indeed, in that flatter effort/reward European environment that is a rational approach at the personal level.
I’m a quant. I look at my portfolio as a single aggregate asset with a single risk and a single reward. I’m widely diversified in non correlated assets but most equities regardless ALL point into the ground in a bear. The correlations all tend toward 1. My solution is to run my portfolio on the efficient frontier and to run my risk at 2/3 of the SPY risk, and let the return be what the return will be. In 2008 SPY went down 50% and I went down 32%. I was even by 2011 and spy was even by 2013. By 2013 I was 15% ahead. I’m not maximizing my return but compounding my return. That 15% was earning me compounding while SPY was sucking wind. Do that 5 times on the way to retirement and you’ll do fine. I started investing the year Vanguard was born so I’ve seen a lot more than 2 downturns. I’m also a fan of rebalancing as a means of risk management. Rebalancing forces you to sell high and buy low. Owning shares you bought low is what makes you wealthy. You can do all the fast money moves you want but in the end it’s time time time and methodical attention to detail that wins. If you’re on the efficient frontier and about 2/3 volatility you will not have paid too much risk for the tiny bit more return a more risky or inefficient portfolio provides.
I went through the tech dump and the 08/09 crash and held on, and kept reinvesting dividends all the way as usual. I more than made up the losses of those short periods of time. In 2009 my partner said to me “shouldn’t you think about selling up?” and my reply at the time. “I’ll sell up when you and all your friends stop spending your money!” It did feel uncomfortable at the time to be losing value. We all spend our money in the economy and those of us who are invested in the economy benefit. If you sell out and only invest in government bonds you are not really part of the economy.
Can you elaborate why buying corporate and government bonds makes you not part of the economy?
Governments issue bonds to build infrastructure and other things. Corporations issue stock or bonds to run their business, depending on which capital structure they think is best.
I’d say governments borrow money to build infrastructure because they have already spent the tax revenue — and because citizens keep voting themselves goodies from the common tax trough, so the infrastructure must be paid with borrowing. And that may one day precipitate a developed democracy crisis that will make the last crisis look like a walk in the park.
Over the past 25 years or so of investing I’ve never really rated government bonds as a lucrative bet. Sure I hold some cash for emergencies etc but my investments are mostly in the stock market. Also, the dividends that they produce are the important thing not the stock value. I don’t feel the fear that everyone else is supposed to feel when the stock market dumps. Maybe bonds are for those who can’t take the roller coaster ride? Even during recessions everyone around me seems to carry on spending so as long as they do that I’ll carry on investing in companies.
Sam: Thanks for this post. In ’08-’09, self-employed with erratic income, at that time 50 years old, three small children, spouse not working, relatively large home mortgage in proportion to my income and assets, high cost of living area, in hindsight overallocated to equities and too concentrated in financials, I took a major hit to my retirement portfolio, which wasn’t all that big to begin with, as I started late. It just so happens right in March ’09 I also lucked out and something I had been working on in my business for two-three years came into fruition and I collected a substantial (for me) fee basically equaling my portfolio losses in one shot.
Running all the numbers, blood running in the streets, etc., I knew intellectually/Warren Buffet says…etc. etc. that was the perfect time to pour it all into the stock market. Perfect opportunity of a lifetime. HOWEVER–under my then life circumstances I simply emotionally didn’t feel I could take any stock market risk with the windfall. Although I felt sure there was probably a 95% positive chance it would work out very well to invest it all in equities at the bottom, still, that 5% chance the market was doing a “headfake” and might go even lower prevented me from doing the “rational” thing. I felt confident that sure in 5 or 10 years certainly everything would be fine. But my immediate concern was having enough of a cash cushion for the next 2,3,4 years that I wouldn’t need to downshift my lifestyle–conservative enough as it was anyway–or that of my family in my childrens’ formative years. I kept the windfall in cash for about a year until I started reinvesting (and after that maintained a very conservative 50/50 ish portfolio between stocks/cash & bonds). I simply didn’t want to put my family in the position of me being wrong, stock market doesn’t rebound for a few years, having erratic cash flow due to my work situation, and quite possibly having to sell the house at the worst possible time to be doing that, and move everyone into a crap rental. Obviously I was mentally worst-case scenarioing it all and my mood was clearly very negative due to what was going on in the financial markets and all the uncertainty. Yes there was blood in the streets, plenty of it was my own, and unlike Baron Rothschild I didn’t have the stomach for any more to pour into the streets. Not right then, anyway.
Thank you for sharing your experience. I can totally empathize as a father now who just wants to take care of this family. Once you have kids, if you’re a normal human being, it’s the well-being of your children and your spouse that matters the most.
If it’s only you to take care of, it’s so much easier to take so much risk. I don’t care as much because I’ll just work harder to make up for my losses. But when my time is taken up by my kids, there is no way in hell that I will give up my time for money instead of to be with them.
I know that life does not get much better after a certain income or net worth. I know this so clearly I wish other people would make The amount or have the amount where they think they will be so happy. So they can see for themselves.
With a 50/50 portfolio, I’m sure you’ve never quite well!
Quick question Sam;
You’ve mentioned that you bought property in 2004,07 (amongst other years) but we’re gun shy to invest much during 2010.
Given the property purchases left you highly leveraged do you think that was a contributing factor in not buying into the stock market pullbacks of 2008-10?
Alex, good point and you are correct. I would say leverage and uncertainty of employment during the downturn’s accounted for about 60% of me being conservative in stocks. The other 40% was simply disliking stocks because of the volatility and disappearing act. At least with real estate, even if you lost 100% of your equity, and he still had shelter. With Stocks, I always just felt like I was being robbed when the stock would go down. How about you?
You nailed it 100% totally agree. Everyone over estimates their risk tolerance unless their portfolio is so high no worries.
Great post Sam. Long time reader, first time commenter.
I’ve been thinking about my true risk tolerance quite a bit lately as I expect we are near the top of the market. I was just starting college in 2008-2009 and didn’t have any capital invested to lose so I’m sure I don’t have a real grasp of my risk tolerance.
At this point I think FOMO is driving my investment strategy. I thought we were near the top of the market a year ago as well and would have missed out on ~25% return if I got out of equities. If we had a major market correction tomorrow I doubt it would crash >30%. Thinking of this, I’m just as afraid of poor timing as a market correction.
I’m curious, a while back you wrote a great post on investment ideas at the top of the market (https://www.financialsamurai.com/investment-ideas-at-the-top-of-the-market/). Do you still consider these strategies as well?
Thanks for all the great work you do!
Hi Adam,
I invested in a couple structured notes since then with downside protection. The most recent one was a iSTOXX Europe Economic Growth Select 50 Index with uncapped upside, 150% of the upside, and 90% principal protection. Note is two years.
I’ve continuously invested in the market, but I do want downside protection.
S
Remember that in some cases even AIG crashes.
This is why it is so so important to mentally prepare beforehand. I find that reading about market crashes, re-visiting news articles from the time, watching television coverage from the time, and reading stories from others who went through the time to be valuable. At the end of the day, investing is entirely mental. People like to chase gains and make investing hard, but sound investing (i.e. some % split between an equity index and a bond index) is easy. The hard part is the mental game. Once you can conquer your emotions, you’re fine. Hopefully you can conquer them before you learn the hard way.
DEAR SAM,
YOUR ONE GREAT FATHER. Happy Fathers Day.
Thanks for all you do, putting your thoughts and fears and emotions into words. And thanks to all who comment.
Give that youngin’ a hug from Nana.
Hang in there, and thanks for the advice and being vulnerable in a world of hard knocks.
Sam, as a 50+ year old, what do I do to prepare for a real estate downturn in the next two years? Keep my rentals, which are geared towards the lower end/college crowd?
Reduce leverage is the key. It will help cashflow in a downturn event and allow you to leverage into more real estate as an option.
So, pay off any mortgages on rentals?
Losing 10% is nothing. There will be times when the stock market will lose a LOT more than that. 50-60% is certainly possible. Losses off 30% somewhere in time are a near certainty. You need to be mentally prepared for this as it will happen at some point. Easier said than done of course, the uncertainty is the biggest problem when investing in stocks. If it was easy everyone would be doing it. You really need to have faith and be optimistic, even during the darkest times when everyone is panicking. I think very few people have the right mindset and personality to deal with this.
If you plan to be almost fully invested in the market and we understand that it is difficult to time the market, then why not implementing a strategy that at least you get paid when the market goes down to offset some of the losses you will have. That at least smooth out the volatility of the P/L of your portfolio. The point is hope is not a viable strategy and hoping the market will eventually come back up after it has corrected is not a strategy a responsible money manager should adopt. We are all money managers of our own portfolios.
I wouldn’t call it hope. Just the conviction that the US and the world as a whole will continue to improve. And that the stock market will be a lot higher 20 years from now. This optimism has worked very well over the last 150 years with an inflation adjusted return of over 5% per year for stocks. But it will be a bumpy ride for sure.
To smooth out the volatility I would use bonds. I’m not really into sophisticated techniques. They usually take a lot more time and add more complexity which I don’t like. Just a simple buy and hold stock/bond portfolio for me.
Somehow you are still playing it safe in the market. You had a starting balance of 500k in August 2017. You’ve deposited 842,500. That’s a negative return or close to 0. You put a tremendous amount in from 2017 til now missing the earlier post bush era gains.
Sorry, I don’t understand. Could you elaborate? What do you think I should do and how are you currently positioned? Where do you see the negative return overall? And are you saying I did not invest in anything before August 2017? Thanks
The power of words is incredible. Above Average Black thinks you lost money overall despite the chart. Well done.
Almost like a magician actually.
500,000 + 842,000 = 1,342,000
Correct @ Andrew
I’m only making an observation
Looking at the chart now. I see that you made money. Maybe I saw something different earlier.
It’s cool. Readers and commenters tend to read what they want to read and express their views regardless of what I write.
I’ve been investing since 1997. This account in my post is one of 8 public investment accounts.
But I do know word magic.
It does require some forms of active investing strategy as opposed to passive investing. The entire discussion would be very lengthy and likely is outside the scope of this forum. The strategy would require the applications of derivatives like options such as short calls/covered calls and/or long puts to hedge against the downside risks. Back-tests show that the strategy would help reduce the P/L’s standard deviation of the portfolio.
Interesting. Where are you in your financial journey and how is your portfolio structured now?
Right now, because of time, I can only actively manage my portfolio on that I have to pay capital gain taxes and I only leave my 401K and IRA portfolios without hedging. I know I am leaving plenty of money on the table regarding my 401K/IRA portfolios without executing my active strategy. I will likely use some kind of dividend plus covered call strategy and/or a variation of synthetic equivalents to manage my IRA portfolios after I retire.
For my taxable account that has over 130 diversified positions, I don’t own that many stocks. For the most part, I have synthetic longs and shorts positions. For those few stocks that I own, I am using dividends and covered calls to reduce my cost bases.
here are other Key Questions:
Did I lose my W2 income? (Not under my control)
How much non W2 income do I have ? ~10k/mo
Do I have a sufficiently large cash reserve to confidently optimize its optionality in a recession?
Planning to have $350k by end of 2018 and $500k by end of 2019.
How much debt and monthly debt service do I have that puts me in fear even if I have cash? $200k primary residence
Will I have skill in the asset classes that crash hardest? Not under my control – if crypto currency is on sale I will miss it.
I am hoping HY bonds, HY loans and Income property crash because this is where my deepest experience is.
My portfolio goes up and down by hundreds of thousands a day. If I didn’t diversify out from a concentrated position, it would be going up and down by millions a day. I am emotionless towards it now. I sat on one holding through an 85% decline during the financial crisis, after which it bounced around the post-crash price for 7 years, and then held it all the way up to today after it went up 4000% from the bottom the past few years. That’s the kind of crap a stock investor needs to be able to stomach. The volatility should be easier to weather for index ETF holders, but people have been conditioned to believe that the stock market always comes back, and relatively quickly. I’m not so sure it will the next time (the government already pulled out all the stops the last time). I guess my outlook begs the question why I don’t just pull out everything now, but it’s capital gains taxes holding me back.