The stock market is a long way into the longest bull market in U.S. history, so personally, I think now is the time to scale down on risk not scale up. But how do I know? The decision to get in, get out, take more risk or take less risk isnât based on mathematical truths or financial ratios; itâs based on purpose. Without purpose, is there any meaning?
Hereâs a question thatâs kept me up many nights: If taking additional risk leads to additional wealth but that wealth is not used by the investor, then was the additional risk worth it?Â To answer this, I come back to purpose â specifically, the purpose of money.
At its most basic level, isnât money just a tool? Fundamentally, tools donât have meaning; they have purpose or use. If you take more risk and gain more wealth but it doesnât further your goals, what was the point?
There are only two final goals, purposes or uses for any dollar thatâs saved or invested. It will either be spent or gifted. Therefore, the choice to take more risk has nothing to do with inverse yield curves, Federal Reserve comments, trade deficits or math. It has to do with your financial goals and the intended purpose of your money.
For example, a couple I advise, Bob and Mary, both in their 70s and in the highest tax bracket, switched to a new certified public accountant (CPA). The CPA advised them to increase the risk on one of their accounts to get more return. They werenât dependent on these dollars and could absorb additional risk, so why not?
As I started to reply, Bob stopped me midsentence, saying he didnât want to take on more risk because he was worried the market would go down as soon as he did.Â Isnât this exactly where many people get lost in debate? This isnât a mathematical debate, yet advisors often make it one.Â
The real question, which the CPA didnât ask, is: âWhat is the purpose of this investment?â If the investment goes up, will Bob and Mary spend more? If not, will they gift more? Spend or give â itâs that simple.
In their case, they said they were already frustrated with how much they must annually withdraw to satisfy their required minimum distributions (RMDs), so I wasnât surprised when they told me they didnât want to withdraw more. Similarly, they didnât want to gift more to their kids. They said they already struggle with whether they are giving too much. Is this really that unusual? Do most people who have accumulated wealth spend more every time they have more? If someone spent more or gifted more every time they had more, would they have anything? Clearly not.
Thatâs not the end of the debate, though. Increasing Bob and Maryâs wealth might not be beneficial while theyâre alive, but it would create a larger estate. Therefore, the sole benefit of increased risk for them was greater wealth transfer upon death.Â Is there any other tool thatâs designed to maximize the transfer of wealth upon death? Is there a way to do this tax-free and guaranteed?
Notice, thus far, math hasnât entered the discussion. While a math conversation can be more comfortable for some, people outside the finance industry generally donât make decisions the way economists and actuaries do. Â
Back to Bob and Mary. They wanted a solution. Easy â itâs life insurance. Everyone understands the basic principle of life insurance: While alive, you pay an insurance company, and when you die, they pay your family.
After a few minutes of discussing life insurance, Bob stopped me and said he didnât want to pay for a policy just to have his children receive more money. I told him, âPerfect!â
I could see he was confused. He hadnât realized that he and I had just clarified his intended purpose. So I asked him, âIf youâre not willing to spend money so your kids can have more at your death, then why are you willing to take more risk so your kids can have more at your death?â In other words, why would you risk whatâs yours for them, but not spend whatâs yours for them?
Bob and Mary didnât need life insurance, but using something theyâre familiar with (life insurance) rather than unfamiliar with (like financial terms such as beta and standard deviation) helped them see that taking additional risk, even if successful, provided no benefit to them or their goals.
Their CPA wasnât wrong. His advice was mathematically correct, but it ignored purpose. Purpose must be at the heart of every investment decision. Imagine youâre a young investor, but you hate losses. Your purpose for investing is greater future spending. Should you invest in the market? Long term, it should be fine, but what about short term?
Iâve met people who every time they lose money, they change their current spending, even though they have years to recover. Although mathematically, investors canât time the market, and short-term market losses will be irrelevant, purposefully for someone like the person described, the negative consequence of short-term losses requires them to take less risk.
However, this doesnât mean they give up on accomplishing their future spending goal. Isnât it possible to achieve greater future spending by investing more? What if they could accomplish their spending goal by investing an additional $500 per month rather than taking additional risk? Wouldnât this be a better solution for them?
In the end, for each investment, you must define its purpose: to spend or to give. At the earliest stages, itâs spending, and at the latest stages, itâs gifting. Then determine if you can accomplish your spending or gifting goal while taking less risk. If you can, then what do you gain by taking more risk? Anything?
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.