Sure, it’s only money, but it’s your money, and it isn’t getting any easier to get more of it.
Zvi Bodie is a Boston U professor and advocate of risk-free retirement income and retirement planning. He and co-author Rachelle Taqqu have a new book out, Risk Less and Prosper, and he was interviewed recently by Morningstar.
He clearly puts things in their proper order. “Personal investing is very personal…before you start to consider investment opportunities, you’re well-advised to understand your goals, wants, and needs, along with your lifetime resources, values, and preferences.”
This is a critical point that many investors have ignored at their peril. The first step is to understand your personal balance sheet, and what your goals and prospects are.
Only once you’ve got a picture of where you are and where you are going are you ready to commit your funds to an investment plan (in the financial planning world, this is called an investment policy statement). No plan, no policy, and you put yourself at risk you may not fully understand.
As Bodie puts it, “These reservations all suggest that personal risk tolerance is an unreliable driver of a personal investment plan. It can play a role, but it is not a key driver. Risk capacity, on the other hand, is very important to understand. A good measure of your risk capacity is the relative strength of your safety net.”
Time in the market won’t necessarily fix ill-advised approaches: “The flaw in the conventional wisdom is to assert that the inherent riskiness of stocks diminishes (dramatically, some say) if you hold them for a very long time. That is simply not true. Think of the weather report. Uncertainty grows over time. It does not diminish. Most of us know that in our bones. What is true is that the longer you hold stocks, the greater your odds of earning the average (superior) return, but also the greater your exposure to severe loss.”
This becomes even more crucial as you advance in years and enter the retirement planning, pre-retirement, and retirement periods of your life. At this point, your opportunities to fix earlier missteps begin to slip away.
Before you commit your resources to a risk asset investment plan, you should ensure that you have a risk-free income floor that can sustain you through your non-working years. The amount of your risk-free income flooring determines your risk capacity.
Get your financial house in order and your money should follow!