My Worst Investment Ever Podcast Enrich Your Future 22: Some Risks Are Not Worth Taking
In this episode of Enrich Your Future, Andrew and Larry Swedroe discuss Larry’s new book, Enrich Your Future: The Keys to Successful Investing. In this series, they discuss Chapter 22: Some Risks are Not Worth Taking.
LEARNING: Don’t put all your eggs in one basket; diversify your portfolio.
“Once you have enough to live a high-quality life and enjoy things, taking unwarranted risks becomes unnecessary.”
Larry Swedroe
In this episode of Enrich Your Future, Andrew and Larry Swedroe discuss Larry’s new book, Enrich Your Future: The Keys to Successful Investing. The book is a collection of stories that Larry has developed over 30 years as the head of financial and economic research at Buckingham Wealth Partners to help investors. You can learn more about Larry’s Worst Investment Ever story on Ep645: Beware of Idiosyncratic Risks.
Larry deeply understands the world of academic research and investing, especially risk. Today, Andrew and Larry discuss Chapter 22: Some Risks are Not Worth Taking.
Chapter 22: Some Risks Are Not Worth Taking
In this chapter, Larry discusses the importance of investors knowing which risks are worth taking and which are not.
The $10 million bet that almost didn’t pay off
To kick off this episode, Larry shared a story of an executive who put his entire $10 million portfolio in one stock.
Around the late 1999 and early 2000s, Larry was a consultant to a registered investment advisor in Atlanta, and one of their clients was a very senior Intel executive. This executive’s net worth was about $13 million, and $10 million was an Intel stock. To Larry’s shock, the executive would not consider selling even a small%age of his stock to diversify his portfolio. He was confident that this stock was the best company despite acknowledging the risks of this concentrated strategy. It was, in fact, the NVIDIA of its day. It was trading at spectacular levels. The executive had watched it go up and up and up.
Learning from the past
Larry pointed out that there were similar situations not long ago, from the 60s, for example, when we had the Nifty 50 bubble, and, once great companies like Xerox, Polaroid Kodak, and many others disappeared, and these were among the leading stocks.
Like this executive, many had invested all their money in a single company and had seen their net worth suffer greatly when these companies crumbled.
This history serves as a powerful lesson, enlightening us about the risks of overconfidence and the importance of diversification.
The Intel stock comes tumbling down
Since he was a senior executive, he believed he would know if Intel was ever in trouble. Larry went ahead and told him some risks were not worth taking. He advised him to sell most of his stock and build a nice, safe, diversified portfolio, mostly even bonds.
The executive could withdraw half a million bucks a year from it pretty safely because interest rates were higher, and that was far more than he needed. Larry’s advice didn’t matter—he couldn’t convince him.
Within two and a half years, Intel’s stock was trading at about $10, falling about 75%. It was not until late in 2017 that it once again reached $40.
Some risks are just not worth taking
Over the period from March 2000 through September 2020, while an investment in Vanguard’s 500 Index Fund (VFINX) returned 6.4% per annum, Intel returned just 1.8% per annum. This stark contrast highlights the consequences of overconfidence and the importance of diversification, making it clear that some risks are simply not worth taking.
Overconfidence blurs out the risk
Larry advises against such overconfidence, stressing the importance of considering the consequences of being wrong. He points out that investing is about taking risks. However, prudent investors know some risks are worth taking, and some are not. And they know the difference.
Thus, Larry adds, when the cost of a negative outcome is greater than you can bear, you should not take the risk, no matter how great the odds appear to be of a favorable outcome. In other words, the consequences of your investment decisions should dominate the probabilities, no matter how favorable you think the odds are.
Marginal utility of wealth
Larry also discusses the marginal utility of wealth, explaining that once basic needs are met, additional wealth provides little extra value. He argues that taking unwarranted risks becomes unnecessary once you have enough to live comfortably.
Larry emphasizes the importance of considering both the ability to take risks and the potential consequences of being wrong. He explains that while youth provides a longer investment horizon, the cost of being wrong is higher when young. He recommends a balanced approach that includes some risk-taking and a stable investment plan, encouraging the audience to think carefully about their investment strategies.
Further reading
- Laurence Gonzalez, Deep Survival (W. W. Norton & Company, October 2003).
- Wall Street Journal, “Portrait of a Loss: Chicago Art Institute Learns Tough Lesson About Hedge Funds,” (February 1, 2002).
Did you miss out on the previous chapters? Check them out:
Part I: How Markets Work: How Security Prices are Determined and Why It’s So Difficult to Outperform
- Enrich Your Future 01: The Determinants of the Risk and Return of Stocks and Bonds
- Enrich Your Future 02: How Markets Set Prices
- Enrich Your Future 03: Persistence of Performance: Athletes Versus Investment Managers
- Enrich Your Future 04: Why Is Persistent Outperformance So Hard to Find?
- Enrich Your Future 05: Great Companies Do Not Make High-Return Investments
- Enrich Your Future 06: Market Efficiency and the Case of Pete Rose
- Enrich Your Future 07: The Value of Security Analysis
- Enrich Your Future 08: High Economic Growth Doesn’t Always Mean High Stock Market Return
- Enrich Your Future 09: The Fed Model and the Money Illusion
Part II: Strategic Portfolio Decisions
- Enrich Your Future 10: You Won’t Beat the Market Even the Best Funds Don’t
- Enrich Your Future 11: Long-Term Outperformance Is Not Always Evidence of Skill
- Enrich Your Future 12: When Confronted With a Loser’s Game Do Not Play
- Enrich Your Future 13: Past Performance Is Not a Predictor of Future Performance
- Enrich Your Future 14: Stocks Are Risky No Matter How Long the Horizon
- Enrich Your Future 15: Individual Stocks Are Riskier Than You Believe
- Enrich Your Future 16: The Estimated Return Is Not Inevitable
- Enrich Your Future 17: Take a Portfolio Approach to Your Investments
- Enrich Your Future 18: Build a Portfolio That Can Withstand the Black Swans
- Enrich Your Future 19: The Gold Illusion: Why Investing in Gold May Not Be Safe
- Enrich Your Future 20: Passive Investing Is the Key to Prudent Wealth Management
Part III: Behavioral Finance: We Have Met the Enemy and He Is Us
About Larry Swedroe
Larry Swedroe was head of financial and economic research at Buckingham Wealth Partners. Since joining the firm in 1996, Larry has spent his time, talent, and energy educating investors on the benefits of evidence-based investing with an enthusiasm few can match.
Larry was among the first authors to publish a book that explained the science of investing in layman’s terms, “The Only Guide to a Winning Investment Strategy You’ll Ever Need.” He has authored or co-authored 18 books.
Larry’s dedication to helping others has made him a sought-after national speaker. He has made appearances on national television on various outlets.
Larry is a prolific writer, regularly contributing to multiple outlets, including AlphaArchitect, Advisor Perspectives, and Wealth Management.
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Connect with Larry Swedroe
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