Risk is usually defined as volatility, Less Antman says, but he defines it slightly differently:
I define financial risk as the probability of not being able to pay for something you need. If someone saves 10% of every paycheck over a 40-year working life and keeps it in the bank, they will have seen virtually no volatility, but will only have around 4 years of income in the bank, since bank accounts typically offer a return after inflation and taxes of nothing, or even a little less than nothing. If they put 10% of every paycheck into a US-only diversified equity portfolio, they would have seen wild volatility, and while an average portfolio would be at 15 years of income, the worst case scenario was only 7 years of income.Now, even assuming the absolute worst result (and notice I’m not even considering the diversification benefits of international stocks, REITs, and commodity futures, which would have raised the worst case considerably), 7 years of income is still better than 4. Who is in more danger of not being able to pay their bills or running out of money? Who is more at risk as a result of their investments?
Here’s the thing. Over periods of time up to around 7 years, the worst performance of stocks has been worse than the worst performance of cash or bonds. Over longer periods, the worst case scenario for stocks has been better than the worst case for cash or bonds. My last newsletter noted that the decade ended 2008 was the worst ever for US stocks, with a 35% real loss, but that T-bills lost 41% in their worst decade. T-bonds lost 43% in theirs.
Over 17 or more years, US stocks have NEVER had a negative real (after-inflation) return, while bonds have earned negative returns after inflation in time periods as long as 56 years. The worst 40 years for bonds lost 60% after inflation (but still before taxes), and it was starting from a low yield comparable to today’s pathetic Treasury yield.
The point is that you need growth in a portfolio unless you are so wealthy that a slightly negative annual return won’t drain all your resources over time. So investments with lower expected returns expose you to the risk of not having adequate growth, which is, in my view, more important to most investors than the risk of a bad year or two.
Antman’s an interesting character with an interesting lifestyle:
I’ve been semi-retired since graduating from college, never working more than 20 hours a week. Except when traveling, my normal wake time is 3 pm in California, after the market has closed, and my afternoons and evenings are spent with Diane, reading, and browsing the Internet. My feeds on Google Reader often lead me to interesting research, and I usually move around the web without plan to confirm or debunk interesting ideas. Sometimes, that’ll get me doing a little spreadsheet work to test out theories or something along those lines. If I’m writing articles, it is usually then.My actual workday starts close to midnight: I check my email and respond to all correspondents, aiming to zero out my inbox every day (of course, I don’t always succeed). I delegate everything that isn’t advice-related to my wonderful administrative assistant, Jessica, whom my clients adore. Most days I then work on one client, keeping in mind that I’m a comprehensive advisor and may not be working on their investments. My total work day averages 2 hours a day, 7 days a week, but is flexible based on what needs doing that day. When I’m finished, Diane and I practice our ballroom dancing, I take my run, then I read to her while she goes through her nighttime routine. We usually get to bed around 6 am or so.
Needless to say, my clients don’t pay me by the hour, or I’d starve to death. They only care that I make their lives better and let them forget about money.
(Hat tip to David Henderson, who was surprised by Antman’s recommendation of commodity futures.)