"Are There Risks of Being Too Conservative?"

I have to admit that I feel a little bit like I am attacking motherhood and apple pie in this article, so let me stipulate up front that I do not believe that any investor should take risks beyond their comfort zone, nor do I think that anyone really has a leg up on being able to predict the direction of the stock market… in the short run at least. In the long run, however, I can predict the stock market direction with great confidence … (cue the drum roll, please) … in the long run, the stock market will be … UP.

I can state that because the economy of the United States has been an amazing juggernaut, overcoming every obstacle and impediment in its path … wars, near wars, political upheavals, assassinations, and all kinds of government mischief in the disguise of various taxes and regulations. And in the face of all that, the U.S. stock markets have managed, ON AVERAGE, to gain about 10% per year throughout the 20th century, while bonds and more secure investments tend to average 3-4% lower. And that difference, simply put, is the “cost” that conservative investors pay for their conservatism.

This type of analysis is basic to financial planning, and most people intuitively understand that with lower risk comes lower potential reward. This topic is always near the top of a financial planner’s agenda when he meets new clients. In one way or another, he or she must ascertain the client’s “risk tolerance,” or “risk preference,” before they can proceed with any meaningful planning.

I used to do this by drawing a nice smooth upward sloping curve, which would represent some kind of risk free rate of return, and then superimpose riskier scenarios, with increasing volatilities, that went both above and below the “risk free” line, but ended up higher, “in the long run.”

So how would you feel, Mr. or Mrs. Client, at this level (when the "risky" lines were below the smooth line)?. Can you stay the course and “look across the valley” when times are tough? Of course, it’s much easier to answer this question in advance than when “the blood is running in the streets.”

I am bringing this up, as promised, in response to a Motley Fool article that identified “Investing Too Conservatively in Retirement” as one of their “Mistakes that Could Cost You a Million.” Now this goes against some pretty long standing tenets of retirement planning, so you have to ask, what has changed?

One of the things that has changed is life expectancy. As I sit here, a male of age 61, I have a life expectancy of just under twenty years. Is that “the long run”? Well, yes and no. We heard a lot about “the long run” in Economics 101 many years ago, but as the professor occasionally pointed out, “in the long run, we’re all dead.” Which of course is true, but what is also true today is that boomers are nowhere as near death in their sixties as our parents were. And therefore, we do not need to be as conservative as our parents were.

The other major change that has occurred is that many of us (80% or so) plan to continue working in some capacity, and therefore have much more “staying power” than our parents did as well. One of the arguments for being more conservative in retirement is that you don’t have the flexibility to ride out an economic downturn when you are drawing down on your investments. So if boomers postpone the drawdown, they can postpone the conservatism, and stand a better chance of earning that extra 3-4% per year “in the long run.”

Personally, I have a goal of postponing the collection of social security until age 70. A corollary of that goal is that I also hope to be a “net saver/investor" throughout that period (and even longer, if possible). In my March 1st blog, “Can’t Get No Satisfaction? Try This,” I used Warren Buffet as an example of being satisfied with his modest home and furnishings in Omaha, Nebraska. Today, Warren Buffet was in the news as having passed Bill Gates to become the richest man in the world. But the most amazing thing about Mr. Buffet? At 82, he’s still working!

If you’ve been around here for any length of time, you know I have a passion for helping people find rewarding “encore careers,” and here is yet another benefit of doing so. Aside from the direct benefits of the money you can earn, and the further benefits of delaying social security, there is this added benefit of postponing the “drawdown phase” of your investing life and the corresponding necessary shift to conservative investing, with its lower returns. So my wish for you (and me) is that we all find gainful pursuits that satisfy our life passions, make use of our talents, and allow us all these direct and indirect financial benefits as well … in the long run. :-) Bob


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