Sunday, September 7, 2008

Risks and the Road to Early Retirement

We may not realize it, but we all make risk assessments everyday in almost everything we do.  For example, some folks will drive nothing but the safest car on the road, typically a Volvo with airbags in every direction, while others ride motorcycles without helmets. 

It’s no different with personal finance.  Some of us are very risk averse - shying away from stocks, investing in bonds, wanting to secure our futures with reliable investments.  While others love taking risks – day-trading stocks, shorting stocks, chasing returns.   Ideally, a smart investor finds a middle ground that will allow for some growth while still maintaining a strong core.

When I first started investing, I would often say that I was willing to take on more risk because I wanted to build a portfolio that would allow me to retire early.  I knew I had to invest in stocks to achieve that.  And I reasoned that if I failed, then I would simply continue to work like every other poor slob until my normal retirement! 

In those terms, it seemed like a no-brainer. Why not take discretionary income and invest it instead of spending it?  While my friends and co-workers bought bigger homes, lavish vacations and more toys, I enjoyed having a "higher goal".  Whenever I mentioned retiring early to them, they looked at me like I was speaking a foreign language.  For many, the concept had never occurred to them. And as they gave it some thought, you could see the painful realization in their faces that they will never be able to do such a thing. 

Many of us have similar goals in life.  We aim to graduate from high school, then college, then we want to land a good job.  What comes next is not so well-defined.  Some wish to climb the corporate ladder, others want their own business, while others seek challenging assignments.  For me, I never desired to ascend into corporate bureaucracy, I never wanted my boss’ job ( even though I did eventually get it).  I wanted interesting work, but even more, I wanted security.  Typical woman, eh?  My goal to retire early was driven by that need and the fact that I prefer to work for myself.   I like my job, but to this day, I would much rather spend time working on one of my personal projects than going in to work.  I craved that freedom and early retirement was the answer.

The real bonus is that now that I have the means to retire early, I also have new-found powers.  I can pick and choose my work assignments, I call more shots, I take off when I want to, I don’t worry about where my career is going, what the boss might say, what co-workers might think, I can walk out any day, any time.  I am in charge!  My job is so much more fun. 

1 comment:

  1. It's been my experience that it's very rare to meet anyone, be they new hire or seasoned professional, that "wants" to work until retirement age. The would all "retire" today if they could. However, ask these same people if they are willing to save and invest a good portion of their income to achieve this goal and the answer is they can't "afford" to- although they can "afford" the latest and greatest toys, clothes, trips, etc...
    It becomes clear that their desire for immediate gratification is stronger than a greater, yet seemingly distant prize.

    In terms of risks, I would argue that long term investing, day trading, and shorting all carry equivalent risk, albeit in different forms, and none of these techniques can be truly deemed superior to the other in terms of risk avoidance. Proper risk management is the key to success in all areas.

    Shorting stocks has been especially maligned by many as being higher risk compared to being long. But if you look at it objectively, the risk is the same. On any given day a stock can move up or down which favors being short or long. What scares most people about shorting is that there is no ceiling and you can lose more than the amount in your account. Well, the same can happen with longs on margin, but let's assume that's not the case here.
    The surprising truth is the risk is less for the short than for the long, and that's due to margin requirements. If the stock keeps moving up against the short and the person does nothing, eventually they will receive a margin call and if they don't respond, the brokerage will start closing their position and they will eventually be out of the market. The long will never receive a margin call so if the stock continues to fall, they can potentially ride it down to zero.
    Those who short stocks are usually better with money management than most longs since shorters know when to close a position in a timely manner- it's a matter of financial survival. I can't tell you how many folks I know who own stocks and yet don't monitor them or have any idea how they are performing. It's just a buy and forget mentality....which raises their risk considerably.

    Even day trading has it's advantages. A true day trader is in and out of the market the same day and thus avoids the risk of carrying a position overnight or through the weekend which can be subject to news events. A few examples of folks being trapped in the market after the market closed are those who owned Bear Stearns, and more recently Freddie Mac and Fannie Mae. The biggest risk in day trading is that your analysis and response has to be faster than with a long term trade. The upside is taking advantage of the volatility of the market where you can potentially make over a years return in one day.

    Congrats on achieving a financial level where you have multiple options- it's what many people say they want but won't do the necessary things to achieve it.