Knowing that you have enough wealth. Staying in the game instead of taking excessive risks.

Knowing that you have enough wealth. Staying in the game instead of taking excessive risks. 1734195

There is a difference between a plan to  building up your wealth and there is another plan to staying wealthy. The key is to know how much is enough.

If you have $50k trying to build up to $500k to be ready for retirement or financial independence,  you tend to take more risks because you have a longer time horizon. You are probably 25 years old thinking  of having wealth to be independent at 50 years old. That’s 25 years old.

You could probably have a 70% equity versus 30% bond allocation. Stocks tend to be very volatile in that at certain points, the equity portion can go down 40-70%. That may be ok (if you have the stomach to take that!) if you are somewhere far from needing the wealth to provide cash flow for financial independence/retirement.

However, suppose you are at 48 years old.  A 70% equity allocation will cause your overall portfolio to take a severe dip. That is ok, if you are not dipping in to get cash flow for expenses.

However, if you draw it down its a double whammy your portfolio loses 30-40% AND  you cut it further by drawing down a percentage of the assets for your expenses. You have less assets to grow back to the previous size or even to an adequate size. This is known as sequence of return risk.

If you are high net worth

This situation gets more pronounced if you are rich with say 15 mil in assets. You can adequately cover your expenses and even more.

Yet, we tend to be very risk seeking in the way we deploy our capital. We always want to grow more.

As a retiree you can put up your full allocation in an ETF that mirrors the NASDAQ index, which are primarily tech and biotech companies. These are higher risk. Or you could put up your full allocation in Gold stocks or Gold ETF.

This portfolio is very speculative, and if you have a good crystal ball you will do ok.

However, if you don’t what happens when they move down 50% and you realize your withdrawal amount is going to take a chunk that will satisfy your expenses but will leave an even smaller asset size to continue to grow.

In both the rich and not so rich scenario, it gets worse if you realize you do not have the stomach for such volatility.

You sell out before the market can recover. This happens a lot.

A lower weightage to equity for preservation

When it comes to preserving wealth, it may make more sense to understand your risk tolerance.

Most of all, it may be more important to know that at 15 mil, you have enough. You do not need to take that exceptional risk.

Larry Swedoe sets up his portfolio with 70% bonds and 30% equity, with the equity deployed in USA small caps, international and emerging markets value. These have historically statistical evidence to outperform large cap by 3-4%.

Setting up this way ensures that even with the higher volatility, a 70% decline would still leave the overall portfolio down by 21%. A wise planner would be able to focus you on structuring a portfolio taking into consideration the behavioural tendency.

You still be able to sleep at night.

Sometimes the name of the game is not to beat your neighbour or the friends you are interacting with.

It is knowing how much you need, what is the way to get there and staying in that game. What is the point of chasing a huge return, when you might sell off at the bottom because you didn’t know its going to be that bad.

A good planner would have been able to explain and help you with stuff in this area, so its important to find one.

A Lump Sum investment in STI ETF near the top of the Great Financial Crisis

In the past I wrote two posts sharing about a friend who starts dollar cost averaging 2 months before the great financial crisis.

You can read about them here:

As a primer, the STI ETF is like a listed unit trust that mimics what stocks are held in the Straits Times Index, an index of Singapore Blue Chips, or largest companies in Singapore. If the index go up 1%, the fund must go up 1% and vice versa. You are entitled to received dividends, as the underlying blue chip business distributes dividends so the STI ETF, at the discretion of the manager, distributes an average dividend. You pay a brokerage commission to buy it and annually there is a 0.3 to 0.4% expense for the internal cost of managing it.

The two articles studies the effects of disciplined dollar cost averaging way to build wealth with a single country based index (Singapore). The second article provides an encouraging result in that the IRR turns out to be 5%.

However, one thing that bugs me is how that original investment 2 months before the GFC would have turned out if its not a dollar cost average, but a lump sum investment.

That first purchase was carried out at $33.61 or some where when the STI index is at 3300. If you study the STI Index you will realize that the price of the index is barely above 3300 for the past 7.5 years.  The highest point reached was 3500 and momentary at 3800.

7.5 years and we are still below it.

The DCA results show that if you put in your hard earned wealth fund in the STI ETF, you would end up positive. In the case of a lump sum, you would have lost money. However the dividends distribute over the past 7.5 years makes up for the disappointment.

A Lump Sum investment in STI ETF near the top of the Great Financial Crisis aCjJWOA

A Lump Sum investment in STI ETF near the top of the Great Financial Crisis bpx8AxR

The IRR up to now is 2.82%. That’s somewhat like an insurance savings endowment’s rate of return. There are folks that tell me this is too low of a return, to justify the kind of stomach wrenching volatility they need to go though. That is fair enough. To invest with this approach you have to understand the philosophy of what is necessary, and a large part of it includes how ETF investing works, what you need to do and behavioural finance (or how your brain will make you do stupid things).

We won’t know what the future would bring, and I find there is too much things sold based on USA based indexing that preaches you will make 7% returns per annum. This is as if all country will mirror the returns of USA.

When it comes to single country index investing, things might not be so simple after all.

Still this studies does show the ability of dividends as a form of market return that should be counted as part of your return, and an important part at that.

The story is not completed yet, there are still many years to go.