Financial Independence in a High Cost of Living Area

Timing the Market and Risk Management are Two Different Concepts

Financial Education, Markets, Thoughts of a Mastermind


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This is going to be more of an investing mindset and thinking post.

I’ve written about the recent run up in the stock market, and also talked about why all assets are worth owning in recent times, but that probably left you with some confusion.

One of the principles of personal finance and investing is “you can’t time the market”. People who take a view on the market, place bets, and hope for the best, on average, typically do worse than overall market returns.

The general advice is simple: invest in low cost index funds and get as close as you can to market returns while paying low fees.

I have no qualms with this advice, and this is something I practice in my investing.

That being said, when you are driving your car and see a cliff, you don’t stay the same speed or speed up.  Similarly, if a market has been going up for 10 years, it might make sense for you to slow down on investing on the stock market and look elsewhere to save up cash or deploy capital.

In this post, I’m going to talk in general about risk management and touch on why risk management is not timing the market.

A Ten Thousand Foot Take on Asset Allocation

Classically, as made popular by Jack Bogle, founder of Vanguard, a portfolio made up of 60% stocks and 40% bonds will perform solidly over time, and up until recent times, was a simple strategy for your everyday person.

In recent times, interest rates have been reduced to near nothing (the Fed Funds rate was held at 0% for 5+ years, and 10 year and 30 year rates were around 2% for a number of years as well).

With these bubble inducing conditions, market participants and investors have shied away from bonds and piled into stocks, sending stock soaring 200%+ in the last 10 years.

Now, many financial advisers, personal finance “experts”, and investing “gurus” are suggesting that as a young person, 100% stocks is the way to go.

First, a question: is going 100% stocks a function of the market (low bond yields) OR is it a function of a statistical fallacy of using past results to solely justify future decisions?

Looking at the past 10 years of market returns, yes, being in bonds would have sub-optimal (by a lot). Even now, I’m not sure it’s a great choice, but at yields have increased and are at least somewhat attractive when compared to stock yields.

At this point, there’s a few questions that make sense to ask. Does 100% or a high percent of asset allocation towards stocks make sense in the near future? What are the alternatives?

“Timing the markets has been proven to be impossible and stupid, I’m going to sit tight.”

Hold on, let’s talk about risk management.

Successfully Managing Your Wealth with Risk Management

For the sake of simplicity here in our discussion, let’s assume that we went through a goals discussion and decided that a 60/40 portfolio mix made sense. We take $100 and buy $60 of stock funds and $40 of bond funds. While looking our account balance every day will drive us insane, we decide to look every year or 2 and reassess.

After 2 years, let’s say that stocks have returned 20% and bonds 10%.

Our portfolio now looks like the following: $60 in stocks is now $72, and $40 in bonds is now $44. Our allocation is not 60/40 anymore, but 61/39.

While this might not reach the level of making an adjustment, what if a different scenario happened? What if stocks returned 30% and bonds only 5%?

Our portfolio now looks like the following: $60 in stocks is now $78, and $40 in bonds is now $42. Our allocation is not 61/39, but 67/33.

I’m not going to labor here with a ton of scenarios because I hope you get the point: over time, our actual allocation in our portfolio will change.

Risk Management is not Timing the Market

Let’s take the second example here. After some time, we now sit at 67/33 and we are going to assess this position.

Two questions come to mind:

  1. Is there something fundamentally different in the markets which might lead to continued success in the stock market? With 30% gains in 2 years (15% a year roughly), that is higher than the average and mean reversion is real.
  2. Did our goals change or are we still looking to maintain a 60/40 asset allocation?

If we still are looking to maintain a 60/40 asset allocation, it’s perfectly rational and reasonable to take 7% of our stock portfolio, sell these shares, and buy bonds.

This is not timing the market, but rather risk management and asset allocation!

Now, thinking about today’s world, I’ve had a number of conversations with people who allocated 90%+ stocks in their retirement and taxable investment portfolios.

After 200% gains in the last 10 years, this probably has sent their allocation towards stocks even higher, and now might be susceptible to recency bias.

Risk management is not timing the market.

Again, let’s go back to the 2 questions above. First, market conditions are not exactly positioned for another massive run-up. Second, unless you are super confident and gung-ho about stocks and truly believe that a 90-100% allocation is right for you, then maybe it’s time to reassess.

Be Rational and Assess the Risk

In the personal finance community, seemingly many people give off a certain feeling that they are super smart because their investments are always going up.

Having seen our stock portfolios go bananas has been fun, but if you are sitting on a pile of assets and considering “early retirement” or a “change of work” at these inflated levels, it might be wise to make a change.

If I was 90%+ stocks and had $1,000,000+ in the markets, I’d be sweating bullets and nervous. Could I emotionally stomach take a 20% decline in the stock market? 30% decline? 50% decline? There’s no guarantee it’s coming back.

If I’m supposedly at the “4% rule” in stocks, and considering a lifestyle change, I’d be thinking hard about capital conservation rather than investment returns.

Taking profits, risk management, whatever you want to call it, is not timing the market. Selling everything and going into something else is timing the market. Taking 10% of an asset class and moving it elsewhere, is prudent risk management and might be appropriate. A 50% decline becomes a 45% decline.

Right now, there are plenty of opportunities in the broader world for asymmetric gains to consider when stocks and real estate are at inflated and elevated levels.

Ultimately, people who are going towards financially freedom are money managers. Risk management and timing the market are different concepts.

Thanks for reading,


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