Retirement plan decisions made easy
Drill Down: Risk in Real Life
The risk concept is the likelihood that our returns will be something other than what we expected. With bank accounts, there is essentially no risk. With stocks, there is a lot of risk. Let’s translate that into dollars and sense.
Imagine that you have $10,000 to invest, and you want to put it away in some investment for 20 years. Maybe it was an inheritance from your Aunt Sadie, or maybe you had a lucky lottery ticket, or perhaps a one-time bonus at work.
I’m going to give you two investment options. The first is like the stock market: an average annual return of 10.7 percent and a level of risk equal to the overall stock market.
The second option has the same average annual return, but twice the risk as the stock market.
We cannot be certain of what return you’ll earn because we cannot predict the future; we can, however, simulate the future. I programmed my computer to imagine that you had 1000 lives in which you invested in the stock market. Then as a second exercise, I programmed it to imagine that you had another 1000 lives in which you chose a more risky investment, one that had the same expected return as the stock market but with twice the risk. In some of your lives you were lucky, but in other lives you were unlucky. The computer kept track of all this for a 20 year investment period of each of those 2,000 hypothetical lives. The results are shocking:
- With either investment, your $10,000 grows to over $80,000 on average.
- With the stock market investment, your nest egg was worth less than what you started with three percent of the time.
- With twice the risk of the stock market, your investment was worth less than the $10,000 starting value 43 percent of the time.
Bill Says: Try to lower risk whenever possible.
I’ll explain soon that there are both easy, and hard, ways to reduce risk. Obviously, we always want to implement the easy risk reduction methods.
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Lesson 1: What the Heck is a 401k, and What’s So Great About It?
Lesson 2: Contributions to Your 401k
Lesson 3: Investments “Cook Book” Approach
» Lesson 4: Investments: How Investments Work
Lesson 5: Loans and Hardship Withdrawals from Your 401k
Lesson 9: Your 401k, Your Other Assets, and Your Life
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