It is a near-sacred assumption in the theoretical study of financial assets that people will only accept more risk if they get a reward for doing so. That’s an assumption based on the history of the stock and bond markets. It seems convincing, yet it is not necessarily true in your unique circumstance.
Persuasive and necessarily factual for all conditions are not the same thing. People should pay attention to that.
Why should I not accept the premise fully?
There is the informal logic flaw called “The Historian’s Fallacy.” People assume the decision-maker knew the same things that people know now. We can all agree that that assumption is absurd. You cannot decide based on what will happen in the future. Decision-makers understand what they know at the time and no more.
Nine years ago, I wrote an article titled, “Are You Smart Enough To Know The Future?” It dealt with decision-making, particularly Ron Wayne’s decision to sell his 10% interest in Apple Inc for less than $2,500. I argued it was a good decision given his position at the time. Given what happened since, you could say it was less than excellent—the Historian Fallacy in action.
Ron Wayne did not know the future and therefore could not act upon it. We see the past and can easily say it was a weak decision.
You use the past to help you make decisions, but you know only some of the past, and what you know may not be helpful to you. Part may not be right at all. Consider what you know because of what “Experts” have told you. That’s “Argument from Authority.” Experts sometimes err, and you should be aware of that.
Your reality is that you do not know and cannot reliably predict the future. The future is the risk, not the investment.
The problem gets worse as we dig deeper.
Consider your capacity limit. No individual has personal risk equal to average risk in the market over a long time. Could be more or less. That’s simple to understand. It does not matter what long-run risk is if you don’t survive the short run.
Never rely on averages. If the average depth of water in a river is four feet, you should not assume you can wade across it without drowning. The same thing holds true for average returns in the stock market. As Keynes postulates, “the market can stay crazy longer than you can stay solvent.”
History is the record of what the historian thought to be relevant. It is perceived only in that context. Perspective matters, From Aesop, “Until lions have their historians, tales of the hunt shall always glorify the hunters.”
Understand your risk profile. It contains three factors
Stay curious about what is happening and periodically update what the past means for you.
Learn to make decisions with incomplete and/or conflicting information
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I build strategy and fact-based estate and income plans. The plans identify alternate ways and alternate timing to achieve both spending and estate distribution goals. In the past I have been a planner with a large insurance, employee benefits, and investment agency, a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business. I have appeared on more than 100 television shows on financial planning, have presented to organizations as varied as the Canadian Bar Association, The Ontario Institute of Chartered Accountants, The Ontario Ministry of Agriculture and Food, Banks – from CIBC to the Business Development Bank.
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