Investing the Sensible Way ... It's All About Balancing Risk and Reward ... Risk is Just a Four Letter Word

Risk is a four letter word, meaning simply that it's everywhere all the time.


We can eat too much or too little, exercise too much or too little, and take too many risks or too few.


But one thing is for certain.We won't be able to steal second base without first taking our foot off first base. Yes, risk is, and to reach our goals, we have to take some reasonable risks.


That said, in investing, the odds are with long term investors who are somewhat knowledgeable of the basics, and further assuming that our savings and investment goals are realistic and properly executed. However, when it comes to risk adjusted long term savings and investing, the use of common sense isn't very common.


Proof most investors are clueless tells the story well:


"Investing is about trade-offs; you simply can’t have it all.


So if you need to make 10 percent above inflation to meet your future needs, but you are only willing to assume minimal investment risk in an attempt to generate those gains, something has got to give.


That give and take — the push and pull of emotions — is inevitable, but . . . investors aren’t particularly accepting of those compromises, and instead are living in a world of unrealistic expectations and conflicting sentiments, leaving them hoping impractically that events will work out their way because they see no other route to success. . . .                                  


{In a recent survey} Americans said they need to earn average annual gains of 9.8 percent above inflation to make their financial needs. . . . inflation since 1964 has averaged 4.2 percent annually, which means the average American has to generate 14 percent (annually) . . . .


The Standard & Poor’s 500 index has an annualized average gain of 10 percent over the last 50 years, meaning it’s unlikely most investors actually achieved their need level in the past; they have little reason to expect to hit the target going forward, even if inflation stays very low for the foreseeable future.


Similarly, more than 70 percent of investors said they would prioritize asset growth over principal protection, but 56 percent say they are only willing to take minimal risk to achieve high returns. .. .                                       


High returns while taking minimal risk is a pipe dream; if asset growth is your priority, taking risk is crucial.


Likewise, three quarters of investors . . . only own investments they understand well, which makes sense until you hear that just one-quarter of all investors surveyed felt their overall investment knowledge was particularly strong.


If they’re not relying on investment knowledge, investors are playing the market the way most people bet at the track or in the casino, by playing hunches. Nearly 80 percent of investors surveyed . . . said they simply follow their gut instinct.


That’s not financial planning.


Countless studies show that whether it’s your gut or your heart, emotions cloud judgment, with typical investors waiting too long for an uptrend to “prove” that it’s time to buy, then bailing when a downturn “verifies” that fortunes have turned. That’s why most investors buy high and sell low, even when that’s clearly not their intention. . . . 


In the end, perhaps the most important questions . . . asked involved what investors would do if their nest egg winds up being insufficient. Nearly half of the respondents said they would continue working, and nearly a third would rely on support from family members.                                        


If that’s not the outcome you want, it’s time to act and invest like it.


You can take few risks — if that’s all you can get comfortable with — provided you save more. You can trust your gut — rather than an adviser — provided you’ve learned enough to build a plan that not only minimizes indigestion but gives you a realistic chance of reaching your goals.


Hope and necessity won’t make your financial dreams come true.


If you are expecting things to work out for you “because that’s what has to happen,” trade some blind optimism for a dose of realism; the one standing between you and your goals is you."


Summing Up


History teaches that we can reasonably expect to earn from a diversified portfolio of blue chip stocks 6% annually in real inflation adjusted dollars over a long period of time. Thus, 10% in nominal dollars with a 4% inflation rate, or 6% in real money, has been the norm.


That historical 6% average annual real rate of return in stocks compares to minimal average annual returns in real estate, money market funds, and bonds (and bonds will be unlikely to earn anything in inflation adjusted returns during the next several years).


Using the compounding rule of 72, $1 invested in stocks by a hypothetical 20 year old should grow to an inflation adjusted $2 in 12 years (6x12=72), $4 in 24 years, $8 in 36 years and $16 in 48 years, or at age 68.


Accordingly, beginning investing as early in life as possible and investing that 'early money' in stocks makes sense to me, even considering the sometimes violent ups and downs of the market.


How about you?


We can all be smart and successful investors over time, but first we have to commit to saving and investing in a dollar cost averaging manner, and then controlling our emotions when markets go up and down, which they inevitably will and sometimes do violently. Then we mostly just sit back, and watch the magic rule of 72 of compounding work wonders for us over the long haul.


It's really that simple.


Find someone you trust to help manage your investments, but don't ever mistake a commission based selling stock broker for an investing pro. While some hand holding for novice investors is necessary in most cases, it need not and should not be costly. Paying any amount over one half of one percentage point of assets is paying too much.


That's my take.


Thanks. Bob.