Northern Flicker wrote: ↑Fri Aug 28, 2020 1:01 am
There have been certain kinds of financial risks that are more than just theoretical because they have occurred before, in some cases many times. Some investors try to at least partially diversify these risks. And there are many investors who maybe have not experienced events like 2000/2002 or 2008/2009 with 15-20 years of savings at stake, and think risk is just a volatility blip from the monotonicly increasing market and from which the market quickly recovers.
I need to stop getting so emotionally invested in the wellbeing of complete strangers on a finance forum, because this terrifies me on their behalf. I don't think that people really understand what it means when they are asked "do you have a high risk tolerance?" Since high risk has meant higher expected returns, I think a lot of people think that means higher risk = higher returns. Period. Full stop. And it really doesn't.
It has taken me a lot of time to get a clear understanding of what kind of risks we are taking on. There is a lot of material out there to argue for buy and hold outperforming active management. To make its point, it tends to focus on time periods where buy and hold looked scary but paid off handsomely in the end. Rhetorically understandable, but somewhat misleading. As your signature points out: risk does not guarantee return.
I think a lot of people have come to understand risk tolerance as being the equivalent of strong moral character: Do you have the courage to hold fast while others are panic selling?
And I wish more people understood that risk tolerance meant: For a chance at better returns, are you able to recover from significant losses and do you want to?
The reason that we say that young people can afford to have a higher risk appetite is because you have more time to work off a shortfall if you invested during one of the periods where stocks underperform T-bills
. You take a bigger risk now because there's a chance that you'll have an easier time later and you're ready to take on the chance that you have a much harder time later. This is relevant to the OP who expressed some regret at the bonds falling slightly during the period they were holding them. Do you truly understand how much of your portfolio you stand to lose if stocks should have a bad time? Remember: gains compound but so do losses.
This is particularly relevant because of the strange period of history we are living in (every period of history is strange). In 2012, AQR released a paper
that showed that when the Shiller PE ratio was higher, expected returns for the coming decade were lower. Here's the table.
I encourage the OP to read it carefully as it gives a sense of the range of outcomes that a 100% stocks strategy can offer over a decade of commitment. Overall, it's a good strategy but notice that there is a not insignificant number of situations where stocks have lost money over 10 years.
At the time, they were raising a concern since the Shiller PE was quite high (the highlighted band). Guess where the Shiller PE is now
There's a lot of good reason to question the Shiller PE's predictive power and there's a wide range of possible outcomes for the future even if you do think it is a strong indicator. But I think anyone going 100% stocks should think carefully about the expected returns of that asset allocation in an environment where valuations are already at historic highs.