math versus risk and probability

[offroad]

So I keep looking at risk and how folks decide to risk only maybe 25% of their savings for a good return. But I cant understand that mathematical thinking.

25% of your money making 5% over a year, is actually 1.25% for the year on your overall money (5% divided by 4). The risk for that money is significant, and the same. Just more or less money if you invest say 100%.

And we say that we need to distribute the risk, by only putting in 25%; but that is a mistaken belief. You are at risk, and you are trying to catch a gain. The funds going up or down is going to be the same on that 25%, or 100%. But the gains will be larger or smaller depending on what you put in. So the risk is the same.

Now if you put 100% of your funds in a account that gets 1.25% gain, with an account that is completely nearly certain. Your risk is much lower. Your gain is the same. So you have less risk.

If you put all 100% of your funds in something that might make 5% then the risk is greater, but still the same as only putting in 25%.

At least in my mind, you might as well make an educated investment and try to get maximum gain on all your funds.

Just some rambling folks and hope this can make a little sense.

 

[Cactus]

Sure you could have a 5% gain. You could also have a 5% loss or worse like right now.

Here is another way of looking at it. I want to retire and live off this money someday, maybe today. So what do I do if I'm currently retired and withdrawing funds to live off of that I wan't to make sure stays there? You stick it in something guaranteed to preserve your capital like the G Fund. How much? Well, that depends on how long you think it will take you to make up a loss like we are currently experiencing. A rule-of-thumb typically says it could take up to 5 years to make up a loss from a crash so if you don't want to be forced to sell low you can stick 5 years of living expense in safety, like the G Fund. How much is that? 15%, 20%,25%. What ever it is you keep it safe. This strategy is called something like buckets of money. It budgets your funds in different withdrawal time horizons where the more distant ones are invested in more risky funds with the hope for greater returns. So you figure all this out and end up with the allocations that looks like something akin to our L Funds. Highly modified of course.

Granted this is hard to do inside TSP with our withdrawal options, but it is one way of looking at it. The way you look at it is what counts because in this game your emotions work against you. If you want to look at the math don't think about how you could be making 5% instead of 1.25%. Think about being 100% in the S Fund since the start of the year where every day you tell yourself this has to be the bottom and we will rally from here only to see another day of losses, some of them 2% - 3% in one day. Now you are @ -12% and realize you only have 88% of your entire life savings left. What do you do? That really is hard to answer if you don't have real money in the game. Why? Emotions! Yeah, it is a game to only put half in and say "I kept half safe" or "I only lost half as much as I could have", but if that is what it takes to keep you from panicking that is what you do. The market is geared to use your emotions against you to get you to buy high and sell low. Your job is to stop that by what ever means works for you. Too many people learn that lesson the hard way.

 

[BooDog]

Sure you could have a 5% gain. You could also have a 5% loss or worse like right now.

..... The market is geared to use your emotions against you to get you to buy high and sell low. Your job is to stop that by what ever means works for you. Too many people learn that lesson the hard way.

Such an excellent post Cactus.

Found this article this morning. How to Survive a Bear Market
Worth the read imo.

 

[peterson82]

offroad,

Also remember that a loss is mathematically worse than a gain (percentage-wise). A quick example:

Starting Amount: $1000

If you lost 10% after the first year your account will be $900.

In order to get back to the $1000 starting amount, the market would have to increase 11.1%.

Also, having money on the side really helps when the market goes down and you can throw money in when (you believe) the market will rise.