I heard a sermon last weekend based on the concept of sacred fear, explained through the analogy of standing at the edge of the Grand Canyon as a simultaneously beautiful and terrifying experience.
On the one hand, you are filled with a sense of the sublime in tandem with a rare perspective of your insignificance in the greater world.
At the same time, one wrong step and you are dead. The need for sure footing and the confidence to balance on a ledge are critical. Self-knowledge is paramount.
While the speaker had more profound questions in mind, sitting in the pews, listening carefully, I reached the conclusion that risk tolerance in investing is a related concept.
No five minute Vanguard survey can adequately assess one's taste for risk.
No statement of bravura about going 100% equities can simulate the nausea of seeing your portfolio drop 50% overnight.
No amount of insisting your hypertrophied genitalia will help you stay the course through a Great Recession can predict your actual response under pressure.
No rule of thumb about age in bonds can incorporate your family money blueprint, that time your dad bet everything on red and the wheel stopped on black and you lost the house.
Sometimes, pursuing DIY finance, you unexpectedly find religion.
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Hey CD,
I often ask myself “what if I am wrong?” That alone snaps me into thinking about backups to my backups.
It is not simply an intellectual exercise. You would have to live with the consequences of being wrong.
Author
Dr. MB,
Having been an avid reader your blog(s) and witnessed your various thoughtful ruminations on backup plans to backup plans, I think of your financial planning and attentiveness as a version of Pascal’s wager (as Gasem has mentioned). When the cost of being wrong is so great, the only rational response is to hedge your bets and tailor your living to mitigate the risk of enduring the worst possible consequences.
You are brilliant thanks to your forever dreaming up “backups of backups.”
-CD
Proverbs 15:33
The fear of the LORD is the instruction for wisdom, And before honor comes humility.
Proverbs 1:7
The fear of the LORD is the beginning of knowledge; Fools despise wisdom and instruction.
Fear is a blessing. A balanced fear forces one to behave in reality. It forces inspection and introspection. Lack of fear allows one to behave not in reality but in a narrative. Narratives are scripts, stories, phantasm. They pretend knowledge and wisdom. Sometimes the narrative is close enough to reality that it works out. 50% of the time red wins. The interesting thing about the failure of a narrative statistically speaking, is it happens slowly and then all at once. If you look at a bell curve half win half loose so the question is when do the losers lose? If your a loser near the mean you may die before the loss overpowers. If your a loser livening 80% away from the mean the chance of loss overpowering is overwhelming.
Curry Cracker wrote an analysis describing how well 2000 and 2008 retirees are doing and he blesses them. Up to 2019 they are surviving but he ignores the upcoming 1 or 2 x 50% drops likely to come and the muted recovery likely to happen due to demographics. If the market is overvalued at 105% it takes 52% to regress to the mean. Three 50% market declines in 20 years is not likely to survive. According to his chart the 2000 cohort started at 1M and presently has 500K 19 years in. If that 500K turns into 250K next year the money is gone in 6 years max, and you have no money for the remaining 4 years so hurry up and die already! To me this is not a plan.
You see you can spin a narrative however you like. Curry thinks everything will be OK, he’s betting his family’s life on that. He has like another 50 years to survive. I have another 20. I think his bet is statistically unlikely so I’m making a different bet. It’s basically Pascal’s wager. If he’s right I die filthy rich and my children will prosper. If I’m right I live to fight another day virtually assured of running out of breath before money.
Fools despise wisdom and instruction. Before honor comes humility.
I didn’t do well emotionally in 1987, 2000, or 2008.
That experience taught me about myself.
I’m about 1/3:1/3:1/3 asset allocation now and quite content.
I agree that you don’t know until you experience it.
Author
My dear Wealthy Doc,
To quote the inimitable Fred Schwed in Where Are The Customers Yachts?:
There are certain things that cannot be adequately explained to a virgin either by words or pictures.
Experience has no substitute when it comes to determining risk tolerance.
Fondly,
CD
This combined with your previous post on the Moron Tax hopefully gives the DIY investor a good education to build a solid financial foundation. I must admit that my 100% equities hypertrophic syndrome made it through the dot-com bust unscathed but couldn’t handle the Great Recession and suffered significant shrinkage both literally and figuratively. Once you have significant skin in the game, the losses hurt more so a mitigation strategy is certainly warranted. I agree with both MB and Gasem, multiple backups and insurance on your insurance minimizes the ultimate risk of NW <= 0.
Author
GasFIRE,
The young and brazen frame risk tolerance as a brash bet at the roulette wheel, and they place it all on red.
The older and battle-scarred frame it as a means of rationally minimizing the inevitable down side, of parsimony and reducing the risk of loss. That’s how, thanks to selection bias, they they made it to that ripe older age in the first place.
As an undergrad we used to tease our grad student friends for the bike helmets they wore on short cross-campus rides.
As a med student, I suddenly realized they were completely in the right. They’d invested sufficient amounts in those brains that they were worth cheaply insuring (with helmets).
My years of failure to recognize this was simply greater proof that my brain had not accumulated sufficient intellect to be worth insuring at that time.
Bernstein says investing is not about getting rich. It’s about not dying poor. Wise words.
-CD