How Do I Know If I Have Safely Won the Financial Game?

Dr William Bernstein gave the following advice when asked: “How much exposure should people have to stocks?”

“A lot of people had won the game before the [2008] crisis happened: They had pretty much saved enough for retirement, and they were continuing to take the risk by investing in Equities.

Afterward, many of them sold either at or near the bottom and never bought back into it. And those people have irretrievably damaged themselves.

I began to understand this point 10 or 15 years ago, but now I’m convinced: When you’ve won the game, why keep playing it?

How risky stocks are to a given investor depends upon which part of the life cycle he or she is in. For a younger investor, stocks aren’t as risky as they seem. For the middle-aged, they’re pretty risky. And for a retired person, they can be nuclear-level toxic.”

– White Coat Investor

In another interview, Dr Bernstein further elaborates what he meant by “won the game”.

“When you have acquired enough money to sustain you for the rest of your life, stop risking it. If you are financially independent but still working, you can dramatically lower the financial risks in your life by continuing to save and letting your investments compound, even if you use a less risky portfolio.

You may go from a 4% initial withdrawal rate to a 2% withdrawal rate. Perhaps you can go from a 60% stock portfolio to a 40% stock portfolio. You do not have to invest on margin either. FI without RE can allow you to lower risk.”

Dr William Bernstein wrote the book “The Four Pillars of Investing”, which is a pretty good data-driven book if you wish to understand markets and why longer-term investing works.

As I grew older, I tend to pay attention to folks who have dived deep into subjects like these and are older. I realize that with age, you tend to balance your technical views with real-life experiences.

Dr Bernstein probably has enough friends who got caught in this investing game even though in his opinion they do not need to.

Why We Continue to Stay In the Game

There are a few reasons why they still do:

1. They do not know that they have won the game. Either they didn’t measure, do not know how to measure whether they have enough. If you do not know whether you have enough, you assume you do not have enough, and just keep ongoing
2. Fear of missing out. It does not make sense to leave money on the table when it is there for you to earn
3. Not understanding that being invested has downsides. This downside is that in the short term, your wealth could suffer from severe downside volatility
4. It is a sport for them. This is more ego-driven

We overestimate our ability to take a lot of downside volatility. When you are young, you can take it because you could take reference that your future earnings potential is many times the unrealized losses in your portfolio, or that your unrealized losses are just 1 year of your annual salary.

De-risking Your Portfolio When you Have Sort of Won

When you are older, near the tail end of your official earning years, the unrealized losses are many years of your annual salary. Thoughts that you are making the gravest mistake of your life will soon cloud your judgment and force you to do irrational things.

If you needed $1 million for your purpose and you have $1.2 million, do you still need a high rate of return?

Perhaps not. You could make do with a lower required rate of return.

To achieve that, instead of a 100% equity 0% bond allocation, you can shift to a 50% equity 50% bond allocation.

In an equities bear market, the returns for this 2 asset class may be as follows:

A 60-year-old investor didn’t realize that he can have exposure to the markets and have a much lower maximum downside risks. A $150,000 unrealized loss on $1 million is more liveable, less haunting, and you have a night of better sleep than a $400,000 unrealized loss.

He still thinks he needs the 7-8% a year return when in reality he can make do with a 4-6% a year return.

How do We Gauge That We have Safely Won the Financial Game?

I was asked recently: How do we know whether we have won the game?

This is a subjective question.

I believe most people have an adverse side to them.

By asking this question, most likely they wish to find out that they have to build up enough wealth such that they do not need to entertain the prospect of going back to work, when they are out of the workforce for so long, just to make ends meet.

I believe the answer is: Your financial situation is so comfortable that you have adequate buffers. Given a few possible downside scenarios your financial situation will still work out comfortably.

You have not won the game if there are some very realistic scenarios that could still derail your plan.

Examples Where You May Not Have Safely Won the Game

For example, you think you need an income of $50,000 a year to provide for your expenses. Based on the 4% withdrawal rate, you have accumulated $50,000/0.04 = $1.25 million.

We can think of certain future low return scenarios where $1.25 million might still not be enough. In some situations, you do not know how long you will live and if you lived longer, you might need more.

If it is an initial 3.5% withdrawal rate, I think it is a pretty reasonable balance between saving enough and a high probability of working out well enough for 30 to 40 years.

But still, we can think of low return bond or equity, high inflation scenarios that may jeopardize the plan. Strictly speaking, the game is not won.

Examples of Scenarios Where the Game is More or Less Won

Now suppose, like what Dr Bernstein said, you have so much that your initial withdrawal rate is just 2%. This means you have $50,000/0.02 = $2.5 million.

The 4% withdrawal rate already factors in some atrocious high inflationary, deflationary periods and is the worst-case scenario.

A 2% withdrawal rate ensures that you spend an even smaller initial amount. If you are living in retirement and your wealth gets shaved 50%, you are spending a 4% withdrawal rate. There are some crazy buffers.

Realistically, you could live with a 50/50 equity/bond allocation to balance growth and volatility.

There are some crazy ones who could have a withdrawal rate of 1%!

Another measure that you have won the game is that your expenses are $50,000, but you buffer in 50% more expenses ($75,000 a year in total) and you can cover this with a bond ladder averaging a 2% interest yield. You need $75,000/0.02 = $3.75 million.

Bond ladders protect against inflation because there is always a bond maturing in the coming year which can be invested in higher coupon bonds in an inflationary environment. The downside is that you need a lot of money to make it work.

In both the very low withdrawal rate and the bond ladder, inflation is considered.

Why It Is So Hard for Someone Who Has “A Lot” To Know He has Won the Financial Game

You will only know you have won the game if

1. you have really good knowledge or have someone who is a real subject matter expert in this area to validate and tell you that
2. your financial independence strategy is fundamentally sound
3. you have adequate buffers
4. your annual expenses are well rationalized, and you have enough money

The above is hard to find because frankly speaking, you can have someone validate your situation and you do not believe them.

You either question their (or your) competency, the reasoning behind why they (or you) think you have enough.

There is a lack of trust.

And so the game may be won but you do not believe you have won it.

There are many who get trapped in this.

I invested in a diversified portfolio of exchange-traded funds (ETF) and stocks listed in the US, Hong Kong and London.

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