Risk vs Volatility
Hello everyone, I’m Mike Hengehold.
I have a question for you today. Let's say the market fell 10% tomorrow, maybe 20% maybe 30% How would that make you feel? And more importantly, what would you do? Well, in the past 20 years, the market has fallen 10% or more at least 11 times by my account. And in 2002 and 2008, it crashed. In 2002 it fell 33%. in 2008 I believe it was 48%, close to 50%. It's pretty scary when it's happening, and yet here we are today at all-time highs.
Over those 20 years, we had a lot of market volatility, and really, no damage was done unless somebody needed to cash out during a bad market and actually realize those losses. What's the point of my history lesson? Well, what I want to do today is distinguish the difference between the concepts of risk and volatility.
You see, living with volatility is inevitable. If we're going to invest in anything that has the potential for a meaningful return, then we're going to get volatility. Going up and down is just one of the things that markets do. The good news is volatility can be your friend, allowing you to profit when stocks go on sale. Risk, on the other hand, is not your friend. Risk is what people take when something bad can happen. Race car drivers take risks. Skydivers take risks. In retirement planning, the risk that we don't want to take is that you won't be able to meet your spending goals because either investment strategies or time horizons were not properly aligned with your spending plans and the relevant protection that you have in place.
How do you eliminate the risk of financial failure while still living within, hopefully profiting from volatility? Well, for starters, you need to have a plan. You need to have a retirement income plan that's based on your family's goals and your financial resources. It's going to be different for everybody.
In addition to the plan on how much you want to spend, you need to include strategies to safeguard that spending. Things like guard rails, estate documents, strategies to deal with financial setbacks should they occur, that might parents that need healthcare that they can't afford that you need to chip in on or if kids get into some problems. Also, one of the hardest things for many people to get comfortable with, especially when they're newly retired and the market is volatile right off the bat, is to become comfortable with the fact that markets are going to do whatever they're going to do over the short term and it's really unknowable. Therefore, a proper time horizon for portfolio planning is really important. Generally speaking, a window of five to seven years is considered appropriate for retirement planning purposes. To avoid the risk of financial failure, you also need to be able to have access to adequate cashflow without selling volatile assets like stocks. Remember, it's not the volatility that creates dangerous risks. In 2002 and 2008 markets crashed and people did find if they weren't forced to sell. It's that being forced to sell in order to meet your cash demands that creates the risk of failure. If you can check those items from a planning perspective, then your risk of financial failures should be all but eliminated. Once it is, then profiting from volatility becomes much easier. To do so, you simply dial back on your equity exposure when markets are expensive, and ratchet them up when they're cheap. However, regardless of your view of the market, your opinion of whether things are expensive or cheap, and so forth, your portfolio should always live within a risk zone or a risk range that supports sustainable withdrawals. Generally, this is going to result in holding an equity allocation of somewhere between, say, 50ish and 70ish percent. And by dialing risk back when stocks are expensive, you'll be less exposed when bad markets happen. And, you'll also have money to invest when stocks go on sale.
That's it for now. As a reminder, HCM and HG are here as a resource for you. If we can lend a hand for you or someone you care about, if they need our services, let us know. Thanks for watching everybody.