Better Investing With No Extra Risk??

Lots of financial advisors like to play up how their clever strategies can help you beat the stock market—often by taking on extra risk. Today I want to share an idea for how you can improve your investment growth without adding any additional risk.

When we talk about risk in investing, what we usually mean is volatility. In other words, how likely is it for the market price of a thing to go up & down unpredictably on short notice. So cash in the bank has basically zero volatility—FDIC-insured banks guarantee the safety of your money up to $250,000 per person per institution. Stocks, on the other hand, are very volatile in the short-term, but tend to grow a lot over the long-term (think 5-10+ years).

The way we find the right mix of investments for you is to look at your goals, timeline, and feelings about risk, then choose the appropriate amount of lower-volatility investments (like bonds & U.S. treasuries) to balance higher-volatility things like stocks & stock funds. And the conventional thinking is that if you want higher investment returns, you have to take on more risk by choosing a mix that is heavier in stocks, lighter in bonds.

My financial planning software uses lots of historical data to calculate the expected average annual return and standard deviation for different types of portfolios. We don't need to get into the statistical weeds here, but you should know that a higher standard deviation means more volatility (i.e., short-term risk).

With me so far?

Here are the assumptions my planning software uses for a 70% stock fund, 30% bond fund portfolio: an average annual return of 8.1% with a standard deviation of 11.7%. Compare that to the assumptions for a mix of 90% stock funds, 10% bond funds: an average annual return of 9.1% and a standard deviation of 14.8%.

So to get just one extra percent in expected growth, you have to increase the volatility by over 3%. Now, that extra risk might be totally acceptable to some people – I happen to have a very high risk tolerance, for example, and can deal with the short-term volatility – but, if you're like most people, taking on extra risk with your money sounds like a bad idea.

So what can you do if you want to grow your investments faster without taking on more risk?

I ran some simulations with the following assumptions: you contribute $100 per month into an investment account with a mix of 70% stock funds and 30% bond funds. What would happen over the next 5-10 years if you changed your investment mix to 90% stock funds, 10% bond funds to (hopefully) get 1% higher returns each year ~OR~ increased the amount you invest by 1% each year, but kept the 70/30 mix?

Here are the results:

After 5 years, you would have about $7,562 if you chose the more aggressive, higher risk 90/10 investment mix. If you instead kept a 70/30 mix and increased your contributions by 1% each year, you would have about $7,504. That's a difference of just $58, but it requires no additional risk. And in that fifth year, your monthly contributions would only be $104.06/month – less than $5 above that $100/month baseline.

After 10 years, you would have about $19,461 if you chose the 90/10 mix and contributed $100/month. With the 70/30 mix, though, you would have about $19,120 and be contributing $109.36/month in that tenth year—less than $10/month above the baseline. Notice that it's almost the same amount of money as the more aggressive investment mix, but without the extra volatility.

Now, it's true: you would probably end up with more money if you took on more volatility risk in your portfolio to get an extra 1% of growth each year. But you could have almost the same amount with no extra risk by instead increasing your contribution by just 1% each year.

What sounds better to you? A more aggressive portfolio, accepting more risk for more growth? Or keeping your risk level where it is and increasing your savings by a small amount each year?

There are no right answers here – some people (like me) are fine with the extra short-term volatility, while others (maybe you?) hate the idea of taking on more risk. If you land on the lower-risk side of that question, may I suggest a strategy of slowly increasing your contributions each year in a deliberate, sustainable way to get *almost* the same amount of growth with no extra volatility.

If you want to have a conversation about investing for the long-term, hit me up. This email address is always checked by yours truly.

Thanks,

Timothy Iseler, CFP®

Founder & Lead Advisor

Iseler Financial, LLC | Durham NC | (919) 666-7604

Iseler Financial helps creative professionals remove stress while taking control of their financial lives. We'll help identify current your strengths and weaknesses, clarify and refine your long-term goals, and prioritize decisions to improve your financial well-being now and later. Reach out today to take the first step.