Risk reduction?

AndrewB22

In another thread, a rightly highly respected member of this forum said that many advisers suggest that if a person has more than enough money to meet their objectives, they might consider reducing their risk. The logic is that if you have enough, why risk it?

I had always thought of that differently. If someone has more than enough, then the surplus has an infinite investment horizon and so can be invested with greater risk, as in the long term that risk is likely to generate greater returns. I’m thinking higher risk in terms of 100% globally diversified equities, not (in my view) stupid-risky like the 3:30 at Newmarket or exotic warrants or crypto.  

I can’t square these two views, and wonder if others have thought this through?  It’s mostly a philosophical point. I know risk is a personal thing but is that all there is to it?  If someone was cold and rational and genuinely was never likely to need the money, what risk level should they take?  

Marcon

AndrewB22 said:

In another thread, a rightly highly respected member of this forum said that many advisers suggest that if a person has more than enough money to meet their objectives, they might consider reducing their risk. The logic is that if you have enough, why risk it?

I had always thought of that differently. If someone has more than enough, then the surplus has an infinite investment horizon and so can be invested with greater risk, as in the long term that risk is likely to generate greater returns. I’m thinking higher risk in terms of 100% globally diversified equities, not (in my view) stupid-risky like the 3:30 at Newmarket or exotic warrants or crypto.  

I can’t square these two views, and wonder if others have thought this through?  It’s mostly a philosophical point. I know risk is a personal thing but is that all there is to it?  If someone was cold and rational and genuinely was never likely to need the money, what risk level should they take?  

But people rarely are cold and rational, which I think is why you're having trouble squaring views which don't need to be squared. There's no 'should' about it.

As you say, risk is a personal thing and it's up to each individual to decide what suits them. For some, knowing they have enough (especially if they don't have anyone else to provide for, either now or on death) means that a low risk environment suits them perfectly. Others with a higher risk appetite will want to go on pushing to see whether...

NedS

I agree it's an interesting dilemma.

I think the first view may be appropriate when just considering the individual in question - if you've already won the game, why keep on playing and would certainly be appropriate where there are enough assets but maybe not a surplus.

The second view seems more appropriate where there are a clear surplus of required assets and one is able to take a generational view to investing where those assets may be required to provide wealth for generations to come.

I consider both views to be valid and as ever, which is more appropriate will largely depend on personal circumstances, not to mention tolerances to risk as already highlighted above.

AlanP_2

If you "have enough" then, if by reducing risk, you can guarantee that you won't run out (but you could if markets dropped and stayed down) then it makes sense.

The ultimate would be all in cash with enough "spare" to allow for inflation.

Typically though none of us get to that point so have to take some investment risk, the level of which will be personal choice.

Got £200k, need £200k why would you put it in investments that might fluctuate by 30%+ (so say £140k to £260k)? It would be more prudent (and in my view sensible) to go with something that offers a likely range of £180k to £220k say.

Got £500k and only need £200k then that is entirely different as suggested. Capacity for loss is one aspect that IFAs consider from what I have read.

Personal circumstances will also affect things.

Attitude when accumulating is different to attitude when that pot is not going to get any more added to it and needs to last an indefinite amount of time through unknown market and economic circumstances.

Whether inheritance is a consideration or not will also influence things. 

Audaxer

AndrewB22 said:

In another thread, a rightly highly respected member of this forum said that many advisers suggest that if a person has more than enough money to meet their objectives, they might consider reducing their risk. The logic is that if you have enough, why risk it?

I had always thought of that differently. If someone has more than enough, then the surplus has an infinite investment horizon and so can be invested with greater risk, as in the long term that risk is likely to generate greater returns. I’m thinking higher risk in terms of 100% globally diversified equities, not (in my view) stupid-risky like the 3:30 at Newmarket or exotic warrants or crypto.  

I can’t square these two views, and wonder if others have thought this through?  It’s mostly a philosophical point. I know risk is a personal thing but is that all there is to it?  If someone was cold and rational and genuinely was never likely to need the money, what risk level should they take?  

If you have more than you will ever need to spend in your lifetime, even after allowing for possible high inflation, there is no real need to invest, especially with 100% equities. The sensible thing to do is probably to dial down your risk level to hopefully preserve your wealth, but unless you plan to leave it as an inheritance, you wouldn't really need to do that, although I think most people on this forum would remain invested to some extent.

dunstonh

You may have multiple objectives and you may apply different priorities to them which may lead to different risk profiles being used with different objectives.

e.g. primary objective is enough for your own lifetime.  Secondary objective may be that you have £xxx that you never are going to use.    If you have children you may have a different view from someone that has no dependents.  So, you may feel differently about how you invest depending on your own scenario.

GazzaBloom

You only need to get rich once...

Albermarle

If someone was cold and rational

As already said, few people are completely cold and rational. The human being is a mix of emotion and rationality, and the mix is different for everybody.

One issue in this debate is that most people are 'loss averse' , in that the pain of losing is much more than the joy of winning.

For example if I needed £200K and had built up £500K ( through hard work/luck/inheritance etc) and I put the excess £300K into a 100% equity fund which then went up 50% , I would feel quite good about that . However if it had dropped 50%. Then although I had no need for the money and still would have £150K of the £300K left, I would still be sick as the proverbial parrot !

So to avoid the latter feeling, I would probably invest at a lower risk level, as a drop of 10 or 20% would be more tolerable, but not very cold or rational. 

Audaxer

Albermarle said:

If someone was cold and rational

So to avoid the latter feeling, I would probably invest at a lower risk level, as a drop of 10 or 20% would be more tolerable, but not very cold or rational. 

I agree but I think the only problem we now have is knowing what is going to be lower risk. An example being that the VLS20 has fallen more than VLS100 this year so far.

JohnWinder

Yes, you can square those two valid approaches.
Firstly, you establish a ‘liability matching portfolio’, safe asset of income sources that will ‘guarantee’ to meet your future needs eg contributions to maximise a state pension; lifetime indexed annuity; non-rolling bond ladder of linkers; aged care insurance policy.
Secondly, you invest the rest in you ‘at risk’ portfolio, as risky as you fancy. Does that square it for you?

Linton

JohnWinder said:

Yes, you can square those two valid approaches.
Firstly, you establish a ‘liability matching portfolio’, safe asset of income sources that will ‘guarantee’ to meet your future needs eg contributions to maximise a state pension; lifetime indexed annuity; non-rolling bond ladder of linkers; aged care insurance policy.
Secondly, you invest the rest in you ‘at risk’ portfolio, as risky as you fancy. Does that square it for you?

The concept of a liability matching portfolio has major benefits over investing all one’s retirement pot in a general 60/40 portfolio with no guarantees on anything.  However the cost of 100% cover for all one’s expenditure could be prohibitive.

One compromise approach is to ensure 100% lifetime  cover for one’s basic needs but perhaps reduce the 100% figure  somewhat  and time-limit it for discretionary expenditure to the medium term, say 10 years. Beyond that reliance on moderate long term real growth of prudent investments could be acceptable.

There is scope for considerable variation in implementation since categorisation into basic and discretionary expenditure is an individual choice and the time periods for 100% cover will be limited by one’s wealth.

As said, any money left over can then be invested to whatever risk one wants.