The Risk of Playing It Too Safe With Mark Biller

Apr 16, 2024

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What is the risk of playing it too safe?

That does seem like a bit of a riddle, but we can start to make sense of it by first exploring a behavioral phenomenon called “loss aversion.” Researchers have found that most people feel the pain of losing money roughly twice as strongly as the joy of gaining money. To say it again clearly: losses feel twice as bad as gains feel good. This naturally causes many people to be “loss averse” and try to avoid losses, sometimes to such a substantial degree that it undermines their long-term goals.

One of the trickiest parts of investing is taking enough risk to meet your long-term goals without taking more risk than necessary. There are very tangible steps we can take to reduce or mitigate risk—things like maintaining an emergency savings fund to minimize the risk of a financial emergency, such as a job loss or an unexpected major expense.

When it comes to investing, diversifying your holdings rather than putting all your eggs in one basket is an example.

Can someone be too risk-averse?

Sometimes, we actually increase our long-term risk by playing it too safe. One example is young people not investing aggressively enough, letting the opportunity for long-term compounding slip away.

This is ironic because young people are often stereotyped as inherently bold risk-takers. We read stories about them buying meme stocks, Bitcoin, and other risky investments.

But the broad research on Gen Z — adults ages 27 or younger — doesn’t back that up. A recent national study found that Gen Zers are the least financially confident generation and 57% think savings accounts are the best way to invest their money. Most financial pros would agree that savings accounts are an extremely conservative choice for those with several decades of investing time ahead of them.

Even the next age demographic, the Millennials (ages 28 to 43), appear to be surprisingly risk-averse. A different Schwab study last year found that Millennials were especially interested in bonds. Bonds are generally the favorite of retirees, not 28-to-43-year-olds.

These surveys indicate that younger investors are arguably too loss-averse and are making investing choices that are likely to impair their ability to build long-term wealth significantly.

It’s fair to point out that previous generations didn’t have that same inclination when they were younger and less experienced investors. There’s a disconnect between making a safe 5% in a savings account or bond today and not recognizing the impact inflation is likely to have on that relatively low rate of return.

Young people should target the higher returns of stocks over the decades they’re saving for retirement so they can grow the purchasing power of their savings at a faster rate than inflation over the course of their careers.

What are you seeing with new retirees?

Retirees often fall into the same trap. A 65-year-old new retiree who has all her retirement savings in cash told us she could live just fine on Social Security and the $450 she took out of her retirement savings each month. When we asked how long her savings would last if she kept taking out $450 each month, she knew the answer immediately—a little more than 25 years.

She had run the numbers and thought she was in good shape. But she isn’t because she failed to factor in the rising cost of living. Because of inflation’s corrosive power, $450 will buy far less in the future than it does today. That means her standard of living will decline steadily as the years pass.

That investor doesn’t want to take any risk. But ironically by playing it so safe, they aren’t just risking the possibility of financial trouble down the road, they’re guaranteeing it.

How do we prevent that from happening?

Investors normally need to accept some degree of risk to prepare for the future. That typically means maintaining at least some exposure to stocks even after retirement age, because these days, a person needs to plan for a retirement that could last 20 to 30 years.

Dialing in that “not too much risk, but just enough” balance is tricky. A good financial advisor or a service like Sound Mind Investing can really help a person figure out an appropriate level of risk and translate that into a portfolio of stock and bond investments.

We’re not a big fan of annuities in most cases, but in the case of the new retiree previously discussed, even an extremely conservative step like buying an annuity with an inflation rider would likely provide her with a higher monthly income while also locking in some inflation protection. So, there are usually things that can be done, as long as a person recognizes the risk of playing it too safe.

What is a better approach in a situation like this?

Mark typically desires SMI investors to have a closer to a 50-50 blend of stocks and bonds as they hit retirement age. If the numbers work, a conservative investor like this might be able to reduce that to 20 to 30% in stock mutual funds or ETFs, with most of the rest in fixed-income securities.

Keeping that little stock growth exposure is one way to improve the odds of having enough money in your later years. Again, we don’t take on extra risk just to grow the most giant pile of money possible, but we need our returns to be higher than inflation to protect our purchasing power.

For most people, that means taking some risk. Yes, try to reduce that risk over time, and don’t take more risk than you need. Recognizing taking too little risk over the long haul can ironically be as damaging as taking too much risk. We have to weigh the risk of action against the risk of inaction.

Investment risk certainly should be managed and minimized to whatever degree. No one gets bonus points for taking more risks than they need to. However, sometimes the riskiest thing you can do is play it too safely.

On Today’s Program, Rob Answers Listener Questions:

I wanted to move some money from a regular annuity into a Donor Advised Fund (DAF). Do you have any funds that you recommend?
I’m calling about a widow that I represent. She sold her small farm property. Her income is so low that she hasn’t paid any taxes over the past 10-11 years. Is she going to have a big tax liability on selling this property?
I have some questions regarding a solar roofing system. Our home is paid for and our insurance company said we need a new roof due to wind damage. We would like to incorporate a solar roofing system when we install the new roof since we would qualify for a 30% tax credit. Is the 35-40% offset on the solar roof worth it as a return on investment for our home?

Resources Mentioned:

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