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Is Your Risk Tolerance Too High?

Is Your Risk Tolerance Too High?Is your risk tolerance too high? This is a tricky question because risk tolerance can change. In my 20s and 30s, I had a high risk tolerance and invested 100% in the stock market. Now that I’m older (and much wealthier than before), I can’t stomach a huge stock market drop anymore. At this point, it is inappropriate to invest everything in equity. I’d probably panic sell at the worst time.

Recently, I’ve been questioning my risk tolerance level. I haven’t looked at it in a couple of years and things change. I’m just a little older, but I am a lot more conservative now. The world economy has been on an extended run for many years and now it is starting to stumble. Life changes so we need to make sure to update our investment style accordingly.

Our asset allocation didn’t align with my risk tolerance anymore so I had to make some adjustment. Today, I’ll tell you why I’m getting more conservative, review my investment history, and share our targeted asset allocation at the end. Read on…

Risk tolerance dropping

The last time I examined my risk tolerance was in 2017. At the time, I changed our targeted asset allocation to 80% equity and 20% bond. That wasn’t too long ago and our life circumstance hasn’t changed much. However, I feel much more conservative now. Most of this is due to current events and future changes. Normally, we have 3 months of expense in cash, but we need more liquidity for a while. Here are the reasons why.

  • Consolidating properties – We are moving into our rental duplex. Our housing expense should drop in the long run, but we need more cash in the short term. We’re putting 2 condos on the market soon and we’ll have to carry 3 mortgages until they’re sold. Yikes! I’ll also have to return the rental deposit to our tenants. Then, we need to fix up the duplex and buy some new furniture. So we need a bigger cash cushion for a while.
  • Mrs. RB40 retires – Mrs. RB40 isn’t quite ready to retire yet and may continue to work for a few more years. However, we’ll have to get ready for a drop in income. She may pull the plug next year if her working environment deteriorates.
  • ParentMy mom just moved to Chiang Mai, Thailand. We’ll send some money to help out occasionally. In the future, my dad probably will need to hire someone to help out and that’ll increase their living expense.
  • World economy – The US economy is still holding up well, but everything else is slowing down quite a bit. The Trump corporate tax cut boosted profits and propped up the US stock market. Things are still good here, but how long can it last?
  • Midlife – Recently, I turned 45. I’m happy with where I am in life and I want to stay here. I don’t want to take unnecessary risks anymore. More money isn’t going to change our life, but less money would make it a lot more stressful. We’re set in our ways now.

All these added up. I’m a more conservative investor today than just 2 years ago. I need to adjust our asset allocation accordingly. Now, let me share my investing experience with you.

The Dot Com Bubble

I started investing in the stock market in 1996, right after I started my engineering career. It took me a few years to max out my 401k and Roth IRA contribution. After that, I started investing in a taxable account. The dot com bubble was in full swing by then. Many engineers became paper millionaires from stock options and grants. I was still young so I didn’t have much invested at that point, probably around $100,000 at the height of the bubble. It seemed like a ton of money then, but not now.

The drop in net worth was very scary because it was the first time I went through a stock market crash as an investor. The big mistake I made was to invest most of my 401k in my employer’s stock. As you can see from the chart below, the stock dropped like a rock in 2000 and went sideway ever since. (Although, they have quite well after I quit in 2012. I must have been holding them back.)

Intel stock

Luckily, I didn’t panic sell like many investors. At the time, my job was relatively secure so I could afford to hold on to my stock investments. I stopped investing in my employer’s stock and gradually moved my 401k to index funds. During the next few years, I kept contributing to my retirement savings, but didn’t really add much to my taxable account. We put extra money toward our mortgage instead of investing in the stock market.

Lessons learned after my first bear market

  1. Don’t invest in your employer’s stock. My employer already gave me stock options, stock grants, stock discount, a job, health insurance, and other benefits. It was a huge mistake to put my 401k in the same stock. That’s putting all the eggs in one basket and it backfired on me.
  2. Keep investing after the stock market crashed. I kept contributing to my 401k and eventually, it recovered and surpassed the previous high. Some of my friends stopped investing in the stock market and they didn’t benefit from the recovery. If I could do it over again, I’d invest in stock instead of paying extra on the mortgage.

The Global Financial Crisis

The global financial crisis was a huge headache for everyone, but I didn’t stress out much. I went through the dot com bubble and I assumed the stock market would recover at some point. In 2007, both of us had secure jobs and we could weather the storm. With that assumption, we doubled down on the stock market. We kept investing in our 401k, Roth IRA, and taxable account. Our net worth dropped 25% in 10 months, but we kept shoving every extra dollar we had into the stock market.

Of course, we didn’t handle it perfectly. We made a big mistake and purchased our condo at the height of the housing bubble. I’m putting it on the market soon and we’ll be lucky to make any money. It would have been much cheaper to buy after the housing bubble popped. There were short sales and foreclosures everywhere. Actually, we did purchase 2 investment properties when the value was reasonable. I figured we’d average down and it worked out. These properties should generate a nifty profit.

RB40 net worth history

More lessons learned

  1. Buy when there’s blood is in the street. The financial crisis crash was bad, but my experience from the dot com bubble told me to keep investing. Buying properties after the housing crash was a good move too. This strategy worked and our net worth quadrupled since the low point in 2008.
  2. Good steady income gave me the confidence to weather the volatility. I did not lose any sleep during the global financial crisis. Our jobs were secure so we felt safe.
  3. I wished we had more money to invest during the financial crisis. Our asset allocation was 100% stocks during this period. It would have been better if we had some bond and cash. Our portfolio wouldn’t have dropped as much and we’d be able to buy more stocks during the downturn.

2018 mini-crash

How did you handle the mini-crash last Christmas? I was busy in Thailand so I couldn’t pay much attention to the stock market. Occasionally, I checked the stock market and it kept dropping. I have to admit I was getting nervous. Luckily, it was difficult to make changes from Thailand so I left our investment alone for the most part. I sold a few stocks to reduce our tax bill, but that was it. This drop made me realize that I need to reassess my risk tolerance.

S&P500 mini crash

Luckily, the stock market recovered nicely since then. Once I got back to the US, I waited for an opportunity to reduce our exposure to the stock market. Around the end of January, I figured our portfolio did well enough and moved quite a bit of our stock investment to the money market fund. Our portfolio will underperform the S&P 500 if the stock market keeps rising, but I’m fine with that this year. We’ll reassess the situation again next year and see where we are in life. Hopefully, our finance will be a bit more stable and maybe I’ll have higher risk tolerance again.

Is your risk tolerance too high?

Have you taken a close look at your risk tolerance lately? If it’s been a while, your risk tolerance might be a little high. Your asset allocation and investment strategy are derived from risk tolerance so it is important to get it right. Here are some reasons why risk tolerance can change.

  • Age– I don’t know about you, but I’m getting more conservative as I get older. When you’re young, you have a lot of time to recover from a loss. At 45, I can’t afford to stumble too hard.
  • Income stability– Our income isn’t stable anymore. My blog income was awesome in 2018, but it doesn’t look good this year. Currently, we can support our lifestyle without drawing down our investment portfolio, but that will change after Mrs. RB40 retires. We need some buffer in the form of cash and bonds so we don’t have to sell stocks at the worse time.
  • Investing experience– I’ve been through two big market crashes and came out ahead. This gives me the confidence to avoid panic selling. We’ll only sell if we need the money.
  • Life changes – retirement, kids, etc..
  • Investing horizon– We probably need to sell some investment to help fund our kid’s college education, but he is only eight years old. There is plenty of time to recover from market volatility. Once our kid is in high school, we’d need to be more conservative with his college fund.

I suspect many investors think they have high risk tolerance after such a long bull market. It’s easy to keep investing when the stock market is going up, but can you do it when the market crash? You won’t know how you’ll react unless you’ve gone through a tough bear market.

Assess your risk tolerance

Fortunately, you don’t have to figure everything out yourselves. If you need help, you can hire a good financial advisor or seek help from reputable companies on the internet. Vanguard has a very helpful investor questionnaire. Check it out if you need help with your asset allocation. There are other helpful sites too. You can see them in this post – How to Figure Out Your Asset Allocation.

I went through Vanguard’s questionnaire and they recommended 60% stocks and 40% bonds for us. I went a bit overboard at the end of January and our bond and cash allocation is now 48%. That’s too high. I’ll try to nudge it down to 40% by the end of 2019. Also, we should have some cash infusion from selling our properties. I’ll need to invest that in real estate crowdfunding and dividend stocks. It’ll take some time to execute, though.

When was the last time you took a good look at your risk tolerance? Can you keep investing through a market crash and subsequent bear market?

*If you need help keeping track of your investments, try using Personal Capital to help manage your investment accounts. It’s very easy to check on your investment and I log on almost every day. Check them out if you don’t have an account yet.

Asset allocation Personal Capital

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