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How much risk do I really need to take?
Old 11-08-2009, 10:33 AM   #1
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How much risk do I really need to take?

For some background, I introduced myself yesterday with this post: Young military officer cautiously planning ahead

This question, of risk taking, is the first thing I wanted to discuss. I bring it up because I am young (23) and the conventional wisdom is that I should be very aggressive with my savings: heavily investing in growth opportunities and buying on every dip.

I mentioned that I'm risk-averse. It may actually be a product of my age, ironically enough. Already, during my lifetime, there have been no less than four legendary market crashes: 1987 (Black Monday), 1990 (Nikkei), 2000 (Dot Com), and 2008. I've been watching what this does to people. As a result, I think I've grown up valuing peace-of-mind over prospects of spectacular wealth. My fiancee is of the same opinion.

That said, I understand all the arguments for long-term equity investing and I have been giving it a try until just recently. I started a Roth IRA in early 2008 and have contributed the max of $14,000 thus far. Today the account balance sits at $11,222, having cashed out last week in anticipation of another big correction. This experience taught me that I'm even more risk-averse than I thought. I found myself constantly checking Google Finance, reading business and economic news, screening for different stocks and funds, and wanting to tweak my portfolio. It's been a good education but I'm afraid that this is no way to live the rest of my life.

I've begun to think that maybe it's just not necessary in my case. I estimate that I'll earn a little less than $2 million (in 2009 $, "regular military compensation") over the next 20 years, plus whatever my soon-to-be-wife earns. After that I'll be eligible for military retirement benefits. It appears that we could retire before age 45 to a modest yet comfortable lifestyle by saving ~25% of our income over the next 20 years, even if our savings grows merely at the pace of inflation. That could give us at least $500,000 in the bank along with my pension of ~$45,000 per year (both in 2009 $) - enough to make early retirement an option without losing sleep at night over fears of seeing our savings wiped out.

I'm curious to hear what you all think of this as a plan. Am I making any serious miscalculations? Has anyone else gone down this road and regretted giving up the chance for more capital gains and a more lavish lifestyle? Or does anyone wish that they had done this themselves?

Tim
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Old 11-08-2009, 10:43 AM   #2
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I am very risk averse as well, so I really understand your point of view. To keep your savings growing at the rate of inflation, you may have to invest some in the market despite its volatility. Certainly bank account and money market interest rates do not seem to be keeping up with inflation recently.

I really like the TSP G Fund, though. It cannot decrease in value, and usually increases by at least the rate of inflation. You might want to look into that fund.
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Old 11-08-2009, 11:00 AM   #3
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Quote:
To keep your savings growing at the rate of inflation, you may have to invest some in the market despite its volatility. Certainly bank account and money market interest rates do not seem to be keeping up with inflation recently.
Some volatility is certainly acceptable. I don't mean to say that I would hold hundreds of thousands of dollars in FDIC-insured accounts. Maybe some money in CD's, but probably most in funds that hold Treasuries, investment-grade corporate bonds, GNMA securities, etc.

I wouldn't lose sleep over a potential 10% or 15% dip in NAV. I'm only worried about the 30%, 50%, 80% losses (which I've been conditioned to expect) and the possibility that we are in a secular bear market similar to what the Japanese have experienced for the last 20 years.

Tim
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Old 11-08-2009, 11:43 AM   #4
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Ahh, yes, conventional wisdom... Be careful with that stuff - it can be dangerous...
With your mil benefits as DINKs -- a very conservative approach is all you really need --
Besides making promotions, surviving deployments, carefully choosing assignments/mentors etc. is much more important -- If you moved anywhere near as much as I did, your DW is going to be finding alot of new jobs and starting over alot. There's also all that biological clock stuff -- transitioning to SI w/ TK or multi-kids is going to take some extra planning efforts... Our first was born before I finished training, the second 1st assignment and the third after my 1st overseas assignment. Soo, they've always been in my ER plans. I didn't seriously start planning until after Major. Conventional wisdom would have told me ER was unrealistic. I delayed until 25yrs for a number of reasons (life happens), but 22/3 would definitely have been very doable even with SI-3K and NO remarkable stock portfolio performance and very conservative ratios...
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Old 11-08-2009, 11:54 AM   #5
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Tim:

Some thoughts to keep in mind while making your plans:

1. No matter how much you and your fiancee like it now, there is no guarantee that you will stay in the Army for 20 years. People change, and the military changes. Repeated deployments to combat zones can wear down even the most dedicated of soldiers. You also will likely have children, which will bring large and probably unanticipated changes in your plans. If you have children and want to pay for their educations, you can rest assured that college tuition inflation will run ahead of general inflation.

2. There is no guarantee that the military retirement system will stay as it is now. i.e. -- that check you are expecting at 45 may not start arriving until you are 65.

3. Official inflation statistics are grossly misleading because they use hedonic regression and eliminate food and fuel. The only inflation that counts is the inflation for things you will buy. Here is one of the many threads on the topic Is the CPI rigged?

4. Any fund invested in treasuries now is very likely to suffer a capital loss, as the Federal Reserve will be forced to raise interest rates (I think by the end of 2010) to compensate for the massive liquidity injection Here is an excellent thread discussing possible Fed action and inflation What to do about the coming inflation (if it comes)?

5. Your views about what will constitute an adequate retirement income will likely change between now and then. When I was 23, I put up with many things that I wouldn't tolerate now.



If I could start again at 23, I would choose a balanced fund like VWINX, OAKBX, DODBX or one of the Vanguard Target Retirement funds as my principal investment vehicle, with side bets into a REIT fund like VGSIX and maybe a commodity fund
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Old 11-08-2009, 11:56 AM   #6
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Read Solin's "best investment book.." for some reassurance.

Also, there's nothing wrong with using a pre-retirement type of allocation when you're young, and just keep it balanced over the years. As long as you're 40-50% in equities you'll probably be OK. Or maybe a target date fund and just forget it's there.
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Old 11-08-2009, 12:21 PM   #7
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For the truly risk averse, there is the 100% TIPS allocation a la Zvi Bodie. He apparently wrote a book about it, but has some videos online as well.
Boston University School of Management

Just be prepared to save 50 times your annual expenses in retirement instead of 25 times.
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Old 11-08-2009, 01:06 PM   #8
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Gumby -- makes some valid points. There is definitely a difference between true FIRE and an ER dependent on gov't largess. Especially, with an ever expanding largess -- IT ain't gonna be pretty if/when that bubble breaks... I guess all you can do is hold on to your tickets and ride the gravy train until it jumps the tracks... And see if you can't get some cushioning to survive the crash... I realize the current public appreciation of the military is riding fairly high, but I've seen sunshine & I've seen rain... lonely times when I could not find a friend, BUT... So consider vet treatment after Civil War, WW-I, Vietnam, even free health care for life promises. A gov't promise is only as good as the latest bill and NOT all changes will be good. I don't see any real guarantees. But then again, IT could all end after 20/12/2012 when the mysterious worldwide calamity is schedule to arrive.
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Old 11-08-2009, 01:22 PM   #9
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Originally Posted by LOL! View Post
For the truly risk averse, there is the 100% TIPS allocation a la Zvi Bodie. He apparently wrote a book about it, but has some videos online as well.
Boston University School of Management

Just be prepared to save 50 times your annual expenses in retirement instead of 25 times.
You forgot about working into your late 70s.
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Old 11-08-2009, 02:12 PM   #10
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I would have thought that anyone entering the military was not averse to risk (of your life for your country) but obviously there are different views of risk for different areas of your life
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Old 11-08-2009, 05:09 PM   #11
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I am risk adverse as well. However it takes a different form.
The risk I am adverse to is running out of money, or needing to go back to work
There are a number of 'safer' investment vehicles out there. Just keep a close eye on inflation and be prepared to deal with it over time.
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Old 11-08-2009, 06:03 PM   #12
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Sell to your sleeping point. If the amout of risk is keeping you up at night, then you need to take on less risk.
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Old 11-08-2009, 06:18 PM   #13
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Tim, you are being wise to carefully consider your risk tolerance. More exposure than you can tolerate can do worse things than messing up your sleep -- it can get you selling equities low and buying them back high. You are a long way from retirement, and unless you're deliberately trying to time the market (which you almost certainly should not be trying to do), you should not be selling based on what the market is doing.

I would consider carefully Want2Retire's suggestion for the TSP G Fund. Although I'm not in that system, I have a good hunk of my assets in a fund with TIAA that provides only modest returns but guarantees principal. That helps me sleep well.

I do think your logic is sound. You anticipate a decent pension, and I don't believe the U.S. will seriously go back on that promise. I think you can, and should, trade performance to reduce your risk.

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Old 11-08-2009, 08:37 PM   #14
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Thanks to everyone for the replies. I'll address a few points now...

1. Call me a fool, but I'm already signed on for 10 years; even more if I exercise certain options in my contract. How many people get through 10+ years but opt out before 20? I don't know.

2. The possibility of the pension going away is a real concern, however remote it may be. That would be the equivalent of losing maybe $2 million in lifetime income. I think that regardless of our investment strategy we'd have to continue working until "normal" retirement age if this happened.

3. I'm aware of the inflation and interest rate risk, and I agree that interest rates can only move in one direction from here - upward, eventually. I understand that the return on bonds over the last 20 years has been sweetened by falling interest rates, and I wouldn't anticipate getting such a high return over the next 20 years. But part of my apprehension regarding stocks is that I just don't see much upside for them either. Looking at Robert Shiller's data, I'm afraid the market still has some ways to go in correcting for the late 1990's bubble. Frankly, I don't know what looks like a good deal right now. I guess that's why having a balanced portfolio probably is best...

4. On being "risk-averse" and in the military... In some ways it is dangerous and unpredictable. But in other ways it offers much more safety, predictability, and stability than civilian life to make up for that. I couldn't even begin to sit here and draw up a financial plan for the rest of my life (as silly as that sounds) if I were a civilian.

Tim
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Old 11-08-2009, 08:44 PM   #15
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You should read Spend Till the End by Larry Kotlikoff and Scott Burns. They show that you should be very conservative at your stage of life since you have just started to save and can't afford to lose it. It goes against most conventional thought, but is well researched and reasoned.
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Old 11-08-2009, 08:52 PM   #16
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Understanding your own risk tolerance is one of the most important aspects of successful investing. So don't let anyone else tell you how much risk you should be comfortable with.

But having said that. You might want to put this supposed "risk" in context. You currently have ~11,000 saved. You hope to have $500,000 in 20 years.

Right now you probably feel like a 30% drop in your savings ($3,300) would be a very big deal. But once you hit the $500,000 mark, you can expect to have a similarly large ($3,300) swing every couple of days or weeks. That will be true even if you are invested 100% in treasury bonds. Viewed in the context of where you will eventually be, today's volatility is really quite small. And yet the pay off potential for putting money at risk over a period of 20 years or more is quite large.
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Old 11-08-2009, 09:40 PM   #17
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Originally Posted by . . . Yrs to Go View Post
You might want to put this supposed "risk" in context. You currently have ~11,000 saved. You hope to have $500,000 in 20 years.

Right now you probably feel like a 30% drop in your savings ($3,300) would be a very big deal. But once you hit the $500,000 mark, you can expect to have a similarly large ($3,300) swing every couple of days or weeks. That will be true even if you are invested 100% in treasury bonds. Viewed in the context of where you will eventually be, today's volatility is really quite small. And yet the pay off potential for putting money at risk over a period of 20 years or more is quite large.
I should make it clear that we're already talking about more than just $11,000... that is only my Roth IRA. We are sitting on another ~$90,000 in financial assets right now (mostly cash) for which we need to develop a strategy.

In any case, I think I see your point that taking a "big" percentage loss today is not as bad as taking an equally big percentage loss 20 years from now, when we'll have much more principal at risk.

Tim
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Old 11-08-2009, 09:56 PM   #18
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1. Call me a fool, but I'm already signed on for 10 years; even more if I exercise certain options in my contract. How many people get through 10+ years but opt out before 20? I don't know.
In 25yrs, I never met anyone who retired from the military and really retired. But at my very first assignment, my boss threw out 12yrs and took a very good job locally. He had stayed too long and his time on station put him on top of every involuntary assignment list they had. He decided to take the hit for the family. Stuff happens, I didn't understand at the time -- it was a gutsy call to say the least. I've seen folks RIF'ed with more than 10 yrs and several prior enlisted twice pass overs for promotion to major put out. Granted the numbers are rather small, but you have a long way to go at this point.
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Old 11-09-2009, 06:37 AM   #19
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Interesting thread. I'd add three comments:
1 As others have said, I'm not sure you can expect military benefits to remain unchanged over the course of your life. I am not in favor of reducing them for our men and women who serve, but with our deficits/debt and fewer workers for each retiree, something has to give.
2 Kids
3 It's important that you understand your risk tolerance, and admirable at your age. But it's sad that you mention only the downside and not the upside. I have been investing for over 30 years and while the losses were painful, the gains more than made up for it. I would not be FI today without equity holdings. Whether history will repeat itself in the years ahead I'd something we all have to grapple with, I hope you'll keep at least 20% in stocks to test your real tolerance. You're not going to become an aggresive investor, and I'm not suggesting you should be, but you may find you have some risk tolerance after all. The past few years have shaken most investors, you're not alone.
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Old 11-09-2009, 07:49 AM   #20
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Quote:
Originally Posted by timwalsh300 View Post
I should make it clear that we're already talking about more than just $11,000... that is only my Roth IRA. We are sitting on another ~$90,000 in financial assets right now (mostly cash) for which we need to develop a strategy.

In any case, I think I see your point that taking a "big" percentage loss today is not as bad as taking an equally big percentage loss 20 years from now, when we'll have much more principal at risk.

Tim
Great start! Over $100k at 23........pretty nice. I was much more aggressive at a young age and even though I knew I had time to recover from a major correction, it was not easy to sit there and do nothing. As a result, I'm heavily medicated today.


I would suggest a balanced approach even at your age. Much easier to stomach. Good luck!
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