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Knowing That We Don’t Know

Knowing That We Don’t Know

| May 17, 2017

Knowing That We Don’t Know

Knowing that we don’t know certain things, and then planning with that in mind can make a big impact on investment results. 

Very few people thought that the stock market would rally 10+% after the November elections.  In fact, I thought it might go down.  But knowing that I didn't know for sure, meant that the portfolios weren't allocated to 100% cash.  If I knew for a fact that they were going to go down, that would be the prudent thing to do of course.  Same thing for Brexit when we had a panic, same thing for the last two China disasters of the day. 

We know we don't know what's going to happen when, so we plan accordingly. 

  • A 30-year-old might decide to have a 100% high-risk “all in” stock account. When the market goes down, they're not going to be able to retire on their relatively small savings anyway, and then they can ride it out and buy more shares for fewer  It's a very survivable event. 
  • A 70-year-old, usually can't afford to lose half of their life savings, or wouldn't want to because they're no longer working, they're living off that money. We plan accordingly by having safer investments in the portfolio.  This helps us ride out the storm we always know is

Let's do some easy math to bring this home.  Generally, a sustainable spending rate on your investments is 4% per year, so if you have $1 million, you can safely live on about $40,000 per year.  A common asset allocation for this time is 60% risk or stock, and 40% lower risk, which is primarily bonds and perhaps some alternative investments. 

So if you have 40% of the portfolio in relative safety or lower risk investments, and a sustainable withdrawal rate is 4%, we are sitting on about 10 years worth of available funds. 

40% / 4% = 10 years!

This allows us to maintain our distributions without having to sell higher risk investments at a steep loss, and ride out the storm of the day.

This is not saying that you should just buy and hold, and stick your head in the sand.  Weekly I am personally reading hundreds of pages to stay current the macroeconomic environment, where the risks and opportunities may be, and our investment committee meets regularly to adjust the portfolios accordingly. 

What this is talking about is large, all-in, or all-out type moves I see far too often with investors. 

One common real world example is the investor who hit it big once out of several home run attempts and then convinced himself that he was brilliant.  He proceeded to lose all of his secure retirement nest egg.  It’s a shame to be rich twice.  After all, the 2nd time isn’t necessary or assured.

I know people that are literally missing out on hundreds of thousands of dollars' worth of gains because they think they know the unknowable.  Hubris or excessive fear is not prudent or attractive, and it usually costs a lot of money.  If you make gut moves like this one or more times with your savings, it can have absolutely catastrophic results.  Beware of mental accounting games we can play in our heads too.  “I haven’t lost until I sell” fallacies etc.

Have a plan, know that you cannot predict the future and stick to it, even though you do know it's going to be really hard sometimes. 

By knowing what you don't know, it will be easier to stick to the plan when the sea swells. 

You’ve got this.

Thanks for taking a look!