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How do you evaluate investment risk?
Old 01-29-2008, 11:42 PM   #1
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How do you evaluate investment risk?

Recent market volatility has had me thinking more about risk. How do you personally evaluate investment risk?

Personally I have never understood the concept of equating risk to standard deviation of returns. I only consider negative standard deviation a risk - I want positive standard deviation Maybe the hedge fund concept of maximum expected drawdown would be more appropriate?

I think many here people focus on portfolio survivability. I think that this would be true for me if I was in distribution phase. In accumulation phase I think the risk of lower accumulation is greater than the risk of loss. The market has an upward bias and stocks are the best performing asset class. That is what has led me to be 100% in equities until I am < 10 years from my cash out date. So I guess I am focusing on maximum expected value right now.

I think Ken Fisher helped clarify some of my thinking about stock risk. Only 4 options are possible:

1. Stocks are up a lot - I win big
2. Stocks are up a little - I win a little, but usually better than cash/bonds
3. Stocks are down a little - I lose a little, but win long term because 1 & 2 are more common
4. Stocks are down a lot - I lose big, especially if I retire that year.

I don't have his book with me, but #4 occurs less than 5% of the years and the distribution is skewed towards #1. He also has some interesting things to say about avoiding #4. It is not common, but some people have built a reputation by avoiding the blowouts vs. a buy and hold strategy.

Not to beat a dead horse, but it also reflects in your attitude towards the whole mortgage debate. Personally I would rather prepay my mortgage vs. invest in a 10 year tbill at 3.5%, but I am investing in the stock market until I have maxed my tax deferred retirement and 529 options.

How do you currently evaluate risk in your investments?
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Old 01-30-2008, 12:20 AM   #2
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David I completely agree with you in the accumulation phase the biggest risk is not taking enough risk, and not achieving critical mass.

Heck I was 100% in equities until 3 years before retiring and now am back to 80% ?!.

One think I will say is that one can get addicted to risk taking (guilty as charged), and I find myself wanting to gamble and buy stocks just for the thrill of seeing them go up and sell. Right after Apple earning I couldn't help myself the stock had dropped from ~200 to $140 including $15+ drop right after earning, market overreaction BUY BUY BUY. Within moments I had buyer regretted. I don't have a clue about Apple's long term growth, is really oversold? I have no clue, plus it doesn't pay a dividend!

10 minute later I sold my Apple stock a few hundred dollars poor a tiny bit wiser. The accumulation phase is fun if you are not risk adverse enjoy why you can.
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Old 01-30-2008, 03:57 AM   #3
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i always say" its no longer about getting rich, its now about not getting poorer" different game and goal now that im pre-retirement
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Old 01-30-2008, 06:39 AM   #4
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Originally Posted by clifp View Post
One think I will say is that one can get addicted to risk taking (guilty as charged), and I find myself wanting to gamble and buy stocks just for the thrill of seeing them go up and sell.
Ain't that the truth... after 25 years of 100% equities, it was like (what I would imagine) drug withdrawal. I finally figured out how to wean myself off of it... I allocate a Las Vegas fund and go there to blow off steam. I leave my portfolio alone (as best I can, ... just purchased a 1 yr corporate bond (for the better rate) to replace my expiring cd ).
Bad habits are hard to break.
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Old 01-30-2008, 06:53 AM   #5
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Risk and reward come together. If you want to make a lot on your investments, there's a lot of risk so you had better have a long time horizon.

Personally I took a lot of risk during the accumulation phase, but have gradually moved from 100:0 to 45:55 (stocks:fixed) ratios during the past 2 years. ER is in 22 months, and I don't want my nestegg to vanish now or shortly after ER. I don't consider myself to be in the accumulation phase any more, even though I am not quite retired yet.

Consistent with my present aversion to risk, my mortgage is and will remain paid off, and I tentatively plan to live in a much more modest home and to live a much more modest lifestyle than many of those with my ER net worth might choose.

Also I plan to wait until 2014 when I am 66 before claiming SS (which I regard as similar to an immediate lifetime annuity). I doubt that SS will bomb, but if it does then I'll consider buying an annuity at that time.

My FIRE is planned to be permanent. After ER, I will never, never, ever have to work for money again.
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Old 01-30-2008, 06:55 AM   #6
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Originally Posted by megacorp-firee View Post
Ain't that the truth... after 25 years of 100% equities, it was like (what I would imagine) drug withdrawal. I finally figured out how to wean myself off of it... I allocate a Las Vegas fund and go there to blow off steam. I leave my portfolio alone (as best I can, ... just purchased a 1 yr corporate bond (for the better rate) to replace my expiring cd ).
Bad habits are hard to break.
That's exactly what I have been doing. I have a account that is just to blow off steam, so that I won't do something stupid with my main portfolio. That account is only 2% of my portfolio, so if I do something stupid it won't be too disastrous.
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