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Home Uncategorised

In investing, as in life, flexibility is the key

by Ram Balakrishnan
August 17, 2008
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We might do all the right things in investing – keep expenses low, not chase performance, stick to the plan even when markets are terrible – and still get low returns just because our investing career coincided with a time period in which market returns were much lower than we expected at the outset. In his book, The Intelligent Portfolio (review), Christopher Jones makes this point:

Even for this conservative allocation [90% fixed income and 10% equities], the range of potential outcomes (in today’s dollars) is relatively wide, especially as the horizon increases. At 30 years out, you could expect to see portfolio values [of a $10,000 initial investment] fall in the range of $13,000 to $31,000 about 90 percent of the time. That is not a trivial spread of potential outcomes.

How does an investor insure against such an eventuality? Unfortunately, not much because any cure (such as investing in low return assets such as bonds) might be worse than the disease as we’ll be exchanging the low probability of a poor outcome for a near certainty of (perhaps) a slightly better one.

If equity returns does turn out to be much lower than we expected ex-ante, we simply have to adapt to it. We may have to:

Save more: Instead of saving, say 10% of our income, we might find that we need to save 12% to make up for crummy markets. Granted, it means we should save 20% more that we planned to but saving money is under our control, market returns aren’t. Or we may opt to save the same as before and revise our plan and spend less in retirement.

Retire later: There is no law requiring that we retire on the exact date that we planned. If markets did not co-operate, we can opt to remain in the workforce for a couple more years, which would give us the opportunity to add more to the portfolio and allow it to grow at the same time. If the thought of retiring later depresses you, remember that a favourable outcome is just as likely with stocks: our returns might be better than our reasonable expectations.

Ease into retirement: Another option is to work part-time, which would allow us to delay tapping the portfolio or at least withdraw less in the initial years. As an added bonus, it would let us test drive retirement on an installment basis.

In other words, when investing, like life, hands us lemons, we can turn it into lemonade.

Related posts:

  1. Finding a Financial Advisor, Part 1
  2. Carnival of Debt Reduction # 19
  3. The Income Tax Cut is Better
  4. This and That
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