Show Notes
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I’ve been doing book tour activities for the past few weeks and gotten a lot of interesting questions, but there is one that has popped up more than others and it usually goes something like this:
“With everything going on in the world, I think it makes sense to pull some risk off the table. My financial plan is in good shape. I’ve saved enough. Why keep taking the risk?”
My first instinct is to ask why. Why do you feel you have enough? And why do you want to take less risk?
Sure, having enough may give you the option to own fewer stocks. Whether you should own a more conservative mix of stocks and bonds depends on what that change would do for your life and what you’d be giving up in exchange.
When this conversation comes up with a client, I’m often trying to understand whether a more conservative portfolio would help that person feel less anxious. Would they watch the market less? Would they enjoy retirement more?
In most instances that I’ve had this conversation with a client, I’ll point out that their financial plan is strong enough that they could actually afford to take more risk. And that can change the nature of the conversation.
The conversations usually don’t end with the client increasing their stock allocation. But recognizing and understanding how much flexibility they have is usually very reassuring. I think it’s because the question they really wanted answered was, “Am I going to be okay?” Or maybe, more specifically “Am I going to be okay if the market falls?”
But since I don’t have a comprehensive financial plan on every listener of the show, I thought today we could work through some important questions about investing once you have enough.
Does having enough money change your need to take investment risk?
It can. A well-funded plan may give you room to accept lower expected returns. But first, we need to define risk.
You might mean a large decline in your portfolio. You might mean the everyday ups and downs. Or you might mean earning too little to support your spending over the next thirty years.
Those are different problems. And there’s no such thing as eliminating all risk.
Moving money from stocks into high-quality bonds generally reduces volatility. It also reduces expected long-term growth after inflation. So even a change we describe as “getting safer” involves a tradeoff.
In fact, whether bonds are safer depends partly on the time period you’re evaluating. In the historical U.S. data studied by Jeremy Siegel, annualized returns after inflation over thirty-year periods varied less for stocks than for bonds.
This is an important data point in understanding why lower short-term volatility doesn’t automatically mean greater long-term security. So that’s why it’s important to first define “risk” in a conversation like this one.
Then we need to understand what you mean by enough.
Most people I work with have a Monte Carlo analysis showing an 80% or greater probability of funding their plan. I’ve always said that risk tolerance is a mix of your ability and willingness to take risk, and the output from a Monte Carlo analysis of your financial plan is a useful measure of an investor’s ability or financial capacity to take risk.
Quick tangent: I don’t love calling it a “probability of success,” because the remaining scenarios aren’t necessarily unavoidable financial ruin. They show where adjustments would be needed to avoid a shortfall. That isn’t a literal forecast of how often we’ll make changes. In real life, the idea is that you would keep reviewing the plan and make adjustments as needed.
But one of the key assumptions in this form of financial planning is that we assume markets will experience downturns with a similar magnitude and frequency as they’ve experienced in the past. The practical implication of that assumption is we don’t have to predict when or why the next downturn will occur—we just plan on them occurring.
We also build conservatism into our assumptions. I discussed the market assumptions in Episode 240, which was one of my favorite episodes of the year. But this entire tangent started because I think a financial plan run through a Monte Carlo analysis can be a useful tool for defining “enough.”
Maybe enough means your plan works across a wide range of scenarios. Maybe you think of it as thirty or forty years of living expenses. For someone else, it’s more of a feeling.
However you define it, I feel like enough means you have the option to do what you want when you want.
We can compare different allocations and see what changes in your ability to spend, handle surprises, and leave money to others. What people who truly have “enough” will find is that several allocations will support the life they’ve planned.
So at that point, the exercise really becomes deciding which one you actually want to live.
It’s less about what risk you can afford and what risk you actually want.
How do you distinguish risk you can afford from risk you actually want?
This brings us back to the investor who says, “With everything going on in the world, I’d like to pull some risk off the table.”
I pay attention to that first part.
The news might be revealing that your portfolio has been making you uncomfortable for a long time. That’s worth discussing. But it might also be prompting a decision based on what you think the market will do next.
So before making the portfolio more conservative, I’d ask: “What would make you want to increase your stock allocation again?”
If the answer is, “When things settle down,” or “After the market falls,” that tells me you’re probably thinking about a temporary move. You want to change your exposure based on where you think markets are headed.
That’s market timing in disguise.
I don’t think most investors who say this consider themselves market timers. They’re often thoughtful people who believe in long-term investing. But you can talk yourself into a market-timing decision using perfectly reasonable financial-planning language.
When I sense this is the case, I’ll sometimes ask: “Would you still want this more conservative allocation if stocks kept rising for the next several years?”
That gets at whether you’re willing to accept the tradeoff. It’s easy to want fewer stocks when you’re imagining a decline. Would you be comfortable with the same decision while watching stocks do well?
The reason to change your allocation should be a change in the underlying assumptions of your financial plan or a change in your risk tolerance. It shouldn’t be your perception of what returns might look like over the next decade.
If you’ve decided you want a less volatile portfolio for the next twenty years, and your plan supports it, that’s fine. What concerns me is repeatedly changing the target allocation as different risks make headlines, while your life and goals stay largely the same.
I mentioned earlier that risk tolerance is a mix of your ability and willingness to tolerate risk. If I’m to lean on financial planning analysis to measure ability, then how do you assess willingness?
For me, I like to talk through past downturns. What did you do? How much did you think about your portfolio? Did it affect your sleep?
The story attached to a decline matters, too.
During the tech bust, investors were questioning whether internet companies could ever justify the prices people had paid. Then came the 2001 recession and September 11. By 2002, accounting scandals raised another fear: could you even trust the earnings companies were reporting?
The financial crisis brought fears about whether the banking system would hold together. At the start of COVID, people were worried about their health, their families, and how long the economy could remain shut down.
In 2022, with inflation high and the Fed signaling more rate increases, sitting in cash until the hikes were over could sound like an obvious move.
Those are very different reasons to feel afraid. Being comfortable through one downturn doesn’t tell us how you’ll react to the next one. Your circumstances may also have changed, especially if you’re now taking withdrawals instead of adding to the portfolio.
This leads me to one of the two reasons I’d support a more conservative allocation for someone who feels that they have enough and want to take risk off the table.
The first is that you can afford it and it would help you feel less anxious. If lower volatility lets you spend less time worrying about money, the expected return you give up may be money well spent.
The second is that a decline could materially change your life. If you plan to retire in a year or two and a bear market would force you to keep working, that’s a reason to revisit the allocation.
Either way, I want to bring the decision back to real life.
Suppose we’re discussing moving from 70% stocks to 60%. We should look at potential losses in dollars and how the change affects your plan. You still have substantial stock exposure, so it won’t make a bear market painless.
So I’d also ask: How would this actually change the way you live your life? Would you eat out more often? Travel differently? Wear different clothes? Live in a bigger house? Like seriously, how would it change your life?
Often, when a plan is comfortably funded under either allocation, the difference in projected wealth wouldn’t change how someone lives. It may affect what they leave behind. And feeling less anxious can itself make life better.
That’s what I want to understand. What would this change actually accomplish for you?
How Can You Invest With Confidence in Retirement?
Morgan Housel has a phrase I like: “Save like a pessimist and invest like an optimist.”
Even once you’ve saved enough, I think both attitudes belong in your plan.
Leave room for a longer life, disappointing returns, and expenses you didn’t anticipate. Then give a diversified portfolio the opportunity to grow through a future that will inevitably include difficult periods.
Your allocation should allow you to do both. For some people, more bonds make it easier to stay invested and enjoy their money. For others, the plan already provides enough flexibility to keep the allocation they have.
So when someone asks me whether they should take less risk because they have enough, I want to understand what’s behind the question.
If they’re really asking, “Am I going to be okay?” we should spend time showing them how their plan holds up and what choices they have.
Once they understand that, we can decide whether changing the portfolio would actually make their life better.
Thanks for listening. Until next time, to long-term investing.
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