Why: Because I've Never Hit a Jackpot...
Burro,
First of all, note that I have not met the ‘C Fund’ return for the past 3 years – so I have not been particularly successful by my or any other measure. Sitting in the ‘C Fund’ would have done me better than all the moving around I did. Hence, after last year, I am moving around a lot less. I got caught up in my own perceived excellence after 2008 and 2009 – yuk, yuk. The AutoTracker is a great tool for both data mining and modesty enhancement.
Anyway, risk is both an objective and a subjective measure. It isn’t what you think it is.
Objectively, it is simply the standard deviation of a fund on its return curve. That sounds awful and messy, but I really don’t mess with all the math anymore. I use Quicken (which continuously updates the ‘Risk’ of indexes that somewhat match ours) and the calculators at
MoneyChimp. But, just to be clear, the objective element of ‘Risk’ is based mostly on the standard deviation of the annual return curve – which means that for any single ‘year’ you can expect to hit the zone 68% of the time.
Subjectively, there is an assumption (most of the time a good one) that divergent assets have divergent return curves. You have heard that stocks will trend up as bonds trend down. BT just made a similar comment in the “Fiscal Cliff” thread. That assumption is more than subjective – it is a very good rule. However, there are collapsing markets (like 2008) where everything but casholla dumped. Regardless, why would Japanese equities dump because General Motors is going bankrupt? Why would a rapidly growing software company get wiped out because Proctor and Gamble lost 10%? So our various funds will poke along on their own curves. Thus, mixing the funds in allocations should smooth the ride quite a bit. One funds peak will coincide with another's ride and yet another's trough.
Thus, when BirchTree sat in the ‘C Fund’ through the entire collapse of 2008 you are assuming that his ‘Risk’ was 100% because he was 100% in equities. In actuality, his
‘Risk’ was 18.82% - meaning that he could expect a return of between -8.26% and 29.38% with an average return of 10.56%. That he landed 3 deviations away was a measure of that market collapse. He didn't panic and allowed the smart money investors to bring his account back to the norm. By the way, because of the differing return curves, his current 20%:C / 80%:I should return between -6% and +22% with a norm of 8% according to Quickens allocation tool (with a risk of 14%). Personally, I don’t like that allocation – but that is what the game is about, eh…
My normal allocations are:
- Aggressive: 2% G, 15% F, 48% C, 19% S, 16% I Expected Return: 6%, Expected Variance: 9%
- Normal: 12% G, 22% F, 39% C, 15% S, 12% I Expected Return: 5%, Expected Variance: 8%
- Conservative: 12% G, 27% F, 37% C, 13% S, 11% I Expected Return: 5%, Expected Variance: 7%
Where ‘variance’ is ‘risk’ and the ‘return’ is inflation adjusted. Yowser. Thus, you can see that my personal goal is to reduce the variance and come closer to guaranteeing my return hits the mark. These numbers come from Quicken's Asset Allocation Tool.
Why then am I not sitting in one of my normal allocations? Because I am an idiot and thought that the idiotic, old, non-practicing lawyers who know nothing of finance that we tend to elect to high office would set a Black Swan to flight. I figured the non-scientific risk was too great to be invested. Thus, in December I made 0.79% while the ‘C Fund’ made 1.70% (most of it just yesterday). That is why I am trying to get away from market timing. I, personally, don’t believe in it as a short term option. I do believe in it on a more long term view – that is, seeing the 2008 crash and the 2009 rebound.
Anyway, hope that helps. Simplest advice is to (1) read Ric Edelman's 'The Lies About Money' and 'The Truth About Money, (2) read Burton Malkiel's 'A Random Walk Down Wall Street', (3) buy Quicken and play with the Investment module, (4) review the
MoneyChimp site, and most importantly (5) know that equities trend up by a large number – say 9% or 10% because greedy capitalistic pigs really want your money and therefore try to set their companies to build and service things you want. So sitting in the ‘G Fund’ when you are trying to accumulate assets doesn't reduce your risk. Why not use the abilities of thousands – or millions – of business people to make money for you. They like it too because it gives them the assets to grow and expand their dreams. Win-win and a bigger pie. Get (5) right and you will be choosing to travel the world by cruise line, jet, or motor home.
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