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Enrich Your Future 22: Some Risks Are Not Worth Taking
14th January 2025 • My Worst Investment Ever Podcast • Andrew Stotz
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In this episode of Enrich Your Future, Andrew and Larry Swedroe discuss Larry’s new book, Enrich Your Future: The Keys to Successful Investing. In this series, they discuss Chapter 21: You Can’t Handle the Truth.

LEARNING: Don’t put all your eggs in one basket; diversify your portfolio.

 

“Once you have enough to live a high-quality life and enjoy things, taking unwarranted risks becomes unnecessary.”
Larry Swedroe

 

In this episode of Enrich Your Future, Andrew and Larry Swedroe discuss Larry’s new book, Enrich Your Future: The Keys to Successful Investing. The book is a collection of stories that Larry has developed over 30 years as the head of financial and economic research at Buckingham Wealth Partners to help investors. You can learn more about Larry’s Worst Investment Ever story on Ep645: Beware of Idiosyncratic Risks.

Larry deeply understands the world of academic research and investing, especially risk. Today, Andrew and Larry discuss Chapter 22: Some Risks are Not Worth Taking.

Chapter 22: Some Risks Are Not Worth Taking

In this chapter, Larry discusses the importance of investors knowing which risks are worth taking and which are not.

The $10 million bet that almost didn’t pay off

To kick off this episode, Larry shared a story of an executive who put his entire $10 million portfolio in one stock.

Around the late 1999 and early 2000s, Larry was a consultant to a registered investment advisor in Atlanta, and one of their clients was a very senior Intel executive. This executive’s net worth was about $13 million, and $10 million was an Intel stock. To Larry’s shock, the executive would not consider selling even a small%age of his stock to diversify his portfolio. He was confident that this stock was the best company despite acknowledging the risks of this concentrated strategy. It was, in fact, the NVIDIA of its day. It was trading at spectacular levels. The executive had watched it go up and up and up.

Learning from the past

Larry pointed out that there were similar situations not long ago, from the 60s, for example, when we had the Nifty 50 bubble, and, once great companies like Xerox, Polaroid Kodak, and many others disappeared, and these were among the leading stocks.

Like this executive, many had invested all their money in a single company and had seen their net worth suffer greatly when these companies crumbled.

This history serves as a powerful lesson, enlightening us about the risks of overconfidence and the importance of diversification.

The Intel stock comes tumbling down

Since he was a senior executive, he believed he would know if Intel was ever in trouble. Larry went ahead and told him some risks were not worth taking. He advised him to sell most of his stock and build a nice, safe, diversified portfolio, mostly even bonds.

The executive could withdraw half a million bucks a year from it pretty safely because interest rates were higher, and that was far more than he needed. Larry’s advice didn’t matter—he couldn’t convince him.

Within two and a half years, Intel’s stock was trading at about $10, falling about 75%. It was not until late in 2017 that it once again reached $40.

Some risks are just not worth taking

Over the period from March 2000 through September 2020, while an investment in Vanguard’s 500 Index Fund (VFINX) returned 6.4% per annum, Intel returned just 1.8% per annum. This stark contrast highlights the consequences of overconfidence and the importance of diversification, making it clear that some risks are simply not worth taking.

Overconfidence blurs out the risk

Larry advises against such overconfidence, stressing the importance of considering the consequences of being wrong. He points out that investing is about taking risks. However, prudent investors know some risks are worth taking, and some are not. And they know the difference.

Thus, Larry adds, when the cost of a negative outcome is greater than you can bear, you should not take the risk, no matter how great the odds appear to be of a favorable outcome. In other words, the consequences of your investment decisions should dominate the probabilities, no matter how favorable you think the odds are.

Marginal utility of wealth

Larry also discusses the marginal utility of wealth, explaining that once basic needs are met, additional wealth provides little extra value. He argues that taking unwarranted risks becomes unnecessary once you have enough to live comfortably.

Larry emphasizes the importance of considering both the ability to take risks and the potential consequences of being wrong. He explains that while youth provides a longer investment horizon, the cost of being wrong is higher when young. He recommends a balanced approach that includes some risk-taking and a stable investment plan, encouraging the audience to think carefully about their investment strategies.

Further reading

  1. Laurence Gonzalez, Deep Survival (W. W. Norton & Company, October 2003).
  2. Wall Street Journal, “Portrait of a Loss: Chicago Art Institute Learns Tough Lesson About Hedge Funds,” (February 1, 2002).

Did you miss out on the previous chapters? Check them out:

Part I: How Markets Work: How Security Prices are Determined and Why It’s So Difficult to Outperform

Part II: Strategic Portfolio Decisions

Part III: Behavioral Finance: We Have Met the Enemy and He Is Us

About Larry Swedroe

Larry Swedroe was head of financial and economic research at Buckingham Wealth Partners. Since joining the firm in 1996, Larry has spent his time, talent, and energy educating investors on the benefits of evidence-based investing with an enthusiasm few can match.

Larry was among the first authors to publish a book that explained the science of investing in layman’s terms, “The Only Guide to a Winning Investment Strategy You’ll Ever Need.” He has authored or co-authored 18 books.

Larry’s dedication to helping others has made him a sought-after national speaker. He has made appearances on national television on various outlets.

Larry is a prolific writer, regularly contributing to multiple outlets, including AlphaArchitect, Advisor Perspectives, and Wealth Management.

 

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Andrew Stotz:

Andrew, fellow risk takers, this is your worst podcast host, Andrew Stotz from a Stotz Academy, continuing my discussion with Larry swedroe, who, for free decades, was the head of Research at Buckingham wealth partners. You can learn more about his story in episode 645, Larry stands out because he bridges both the academic research world and practical investing. And today we're diving into a chapter from his recent book, enrich your future. The keys to successful investing in the chapter is chapter 22 and it is some risks are not worth taking. Larry, take it away. Yeah.

Larry Swedroe:

So as we always do in my book, we begin with an analogy that has nothing to do with investing to help people understand the difficult concept. And the analogy I came up with for this chapter to help think about what risks and investing are not worth taking, is from one of my favorite books by a phone named Lawrence Gonzalez called Deep survival, about how to survive in the wilderness, for example, if your plane crashes or something. And he described this particular situation, he said there were eight snowmobilers that had just completed a search and rescue mission. They stopped at the base of a hill well known for climbing what was called hammerheading. Hammerheading is where you race up this hill until it gets to see how high you can go on that hill. Okay, till and the one who wins is the one who can get up the highest the I you know, the this particular Hill, though, was known to be dangerous, that avalanches could be caused. Now these are professionals number one, who should know better than anybody, and should know what risks are worth taking or not. But of course, their confidence in their skills could lead to that all too human trait we discussed before, called overconfidence, and two of the eight couldn't resist. One of them went up quickly, and then the other said, Well, if he's going, I'm going to go to unfortunately, the sound of their engines triggered a avalanche, and both of them died. That's what we mean by that. There are some risks that clearly are not worth taking, because the consequences of being wrong, if the risks show up, are so bad that you should never take the risk, regardless of what you thought the odds were. Let's say these people said, Yeah, could be an avalanche, but it's a 1% chance. It's just not going to happen? Well, if you did it 100 times, one of those 100 and you're dead, you know. So then, how does this relate to the world of investing? This was around late 99 early 2000s I was a consultant to registered investment advisor in Atlanta, and one of their clients was a very senior Intel executive. And this executive net worth was about $13 million almost all of it was an Intel stock, and he was confident, of course, that this stock was, it was the best company. It was, in fact, you might think of an analogy. Here was the NVIDIA of its day. It was the chips that was powering the whole.com revolution, okay, trading spectacular levels. He had watched it go up and up and up. And I pointed out that there were similar situations not all that long ago, from the 60s, for example, when we had the Nifty 50 bubble and once great companies like Xerox and Polaroid and Kodak and many others disappeared, even great computer Companies who led the whole innovation era in computers, like data, general digital equipment, they were gone already, and these were among the leading stocks. And he was convinced that, because he was a senior executive, he would know, and I pointed out to him then that some risks are just not worth taking. Have $13 million sell it all, or most of it, and then just build a nice, safe, diversified portfolio, mostly even bonds. You could withdraw a half a million bucks a year from it pretty safely, or maybe more in those times, because interest rates were higher and that was far more than he needed. Didn't matter. Couldn't convince them within literally, like a year or so, if my memories was correct, the 13 became three, and the stock has never recovered, even 30 plus, or roughly 30 years later. Now to that price, that's an example of. Some risks are just not worth taking, regardless of what you think the odds are. And whenever I have stories like that, I'm always reminded, I think, correct me if I'm wrong here, Andrew, but I think we've discussed Pascal's Wager before, so that's where Blaise Pascal, the mathematician, said, Look, you can't prove whether there is a God or not. It's a belief. So how should you act, given that you can't prove it? He said, Well, think about the consequences of your action. If you believe there is a God and you're wrong, what's the consequence? Well, you led a good life. You on your tombstone will say he was a good father, good husband, great friend. Maybe you missed out on a few good frat parties or stuff like that

Andrew Stotz:

because you called a code of ethics that was built around that religion. Let's say yep,

Larry Swedroe:

yeah, right. Exactly. On the other hand, if you believe there is not a god, and it turns out you're wrong, then, at least according to Christian theology, you're doomed to burn in hell for eternity. So it doesn't matter what you think, because the consequences of being wrong are so bad, you should act as if there is a God. And that's the mistake this Intel executive made. He should not have said, I think this is a great company. Odds are great. It doesn't matter. You should think about the consequences of being wrong, because none of us has a clear crystal ball.

Andrew Stotz:

And you know, I think I've also told the story of my the advisor, that when my mom and dad, when they first retired or went, went to North Carolina and retired there, because my dad had a portfolio that was probably both, you know, my mom, my mom and dad's portfolio was probably 70 or 80% DuPont stock because they had been given incentives to buy it where they were buying it at below market prices. So my dad was, or

Larry Swedroe:

after the bull pal incident,

Andrew Stotz:

that's good question. This was 1992 so I can't remember. Bhopal was probably before that. I think that's and, but I think wasn't both all Union Carbide. I can't remember now,

Larry Swedroe:

maybe it was union COVID. You may be right. I But, but the point

Andrew Stotz:

was, was that they, they went to meet this financial advisor, and they said, how can you help me? And he said, Well, first thing I'm going to do is I'm going to reduce that DuPont stock in your portfolio. And my dad said, over my dead body, you will. And my mom was sitting there listening to it all, because she recounts this story now at 86 and I tell my students about it, because my mom basically said she was listening in and, you know, just observing. And the guy said, you know, DuPont stocks, what, you know, 100 or whatever it was at the time, what would happen if it went to, you know, 20, you know, and my dad, you know, my dad said it is never going to go to 20. It's Dupont. So next topic, well, this guy worked hard on my dad, and eventually he reduced the portfolio of DuPont stock, got him diversified, so maybe he had 15% 20% DuPont stock, or whatever it was at the time. And sure enough, my mom told me, DuPont stock went to 20 and luckily, they had gotten out before that. But you know, it's just a great example of, you know, no matter how much you love it, everything can go down.

Larry Swedroe:

Yeah. And the other point that investors should learn is once you have enough to live the life that you're comfortable with, doesn't mean you get everything you want, but you have everything you need to live a high quality life and enjoy things, right? Why do you want to take the risk of that happening when you have no need to do it anymore? Because the marginal utility of wealth is close to zero once you have enough. Whatever that number is, for most people, it might be, you know, they can generate 100 and, say, 20,000 a year. So it's 10,000 a month. You can't live on 10,000 a month. You know something might be wrong with your value system, but whatever the number is for you might be 20,000 a month or 30 but once you reach that number, why are you taking more risk than you need to take when the upside is not going to change your life in any meaningful way. Maybe you can buy a portion instead of an Acura, but that doesn't change the quality of your life in any meaningful way. Or you know, so

Andrew Stotz:

why take the risks? And can we invert this and say when you're young, you should take the big risks?

Larry Swedroe:

I wouldn't say should? I would say you have more ability to take the risk youth is only one thing in your favor. There you have more horizon, and you have the ability to generate new capital through your wages, but your ability to absorb the stomach acid of the markets. You know, going way up and down should play an important role there, and your ability to take risks should also and by that we mean if you've got a stable job, you're a young doctor, and you've got a good practice, and your income is stable, you want to take some more risk, I'd say fine, because you get another global recession, your income might come down slightly, but it's not going to be impacted in any meaningful way, where, if you're a construction worker, an automobile worker, you could get laid off and out of work for years, and now you have to sell your portfolio to generate Cash Flow, and then you can't recover because it's been spent already.

Andrew Stotz:

And before we wrap up, can you just settle one of the disputes I had with a good friend of mine. His name's Eric, and he always gives the advice, you know, take risks while you're young. And in my book, How to start building your wealth investing in the stock market, I say, don't make mistakes when you're young, because the compounding effect of a mistake. Let's say you make a bet you're 25 and you got excess cash, so you basically give it to a friend to go do a restaurant, and he loses it. Well, you've just lost the potential to have 500,000 you know, a million dollars when you're 60. So be very thoughtful about the, you know, mistakes that you could possibly make. But he's like, no, no, the world is clear on this. Andrew, make your mistakes while you're young.

Larry Swedroe:

Yeah, well, I think you're both right and you're both wrong. Okay, you're both right in the sense, or he's right in the sense that you have more ability to take risk when you're young, right? You have more time horizon to wait out. You could take a lot of equity risk. You get a bear market as long as you're employed, the bear markets actually help you, because you get to buy more you know, at lower prices and expected returns are higher if you are a 25 year old, say, a 30 year old, and you've now, and it's 2000 and you've just paid off your debts, your student loans are paid off, and the market crashes, and now you're first able to invest. That was the best thing that happened the 30 year old and 95 in that situation, he's buying at higher and higher prices, right. On the other hand, if you're 65 years old and you're withdrawing, the worst thing that can happen is a bear market early, because you can't recover. So one you do have more investment horizon. So he's right, but you're also right. The cost of being wrong is infinitely higher when you're young, because, as I point out, when I talk to people who evaluate sending your kids, say to a private school or a good public school, and they say, well, it's costing me say 20 grand a year extra. I said, No, it's costing you a million and a half dollars in your retirement, and that's worth X 1000s a year on withdrawal. Now I'm not telling you shouldn't send the kid to the private school, but you have to think about the compounding and the expected return on that investment. That's the real cost. So you're both right, but You're both wrong in that you have to look at the picture in a more holistic way, and not just consider your ability to take risk, which is the only thing he's considering there, and you're looking at the downside without also looking at your ability to be able to take more risk. So you could do that,

Andrew Stotz:

that should be found. Maybe the answer is, when you're young, start your investment account, you know, and start that and start contributing to it, and you know, but it's not all of your money. You can risk it on some other things.

Larry Swedroe:

You can take a portion of the portfolio and say, I'm willing to take this portion and put some risk, but start on my plan, and most of it will go into that investment plan that you know is a more rational diversification of risk.

Andrew Stotz:

You know, these days the stock market's pretty high when you particularly look at the top five to 10 companies, and a lot of times we look back at 2000 the.com bubble and compare, but the difference is that these companies are highly profitable. Now, in those days, companies were really not very profitable, but when you talked about Nifty 50, it made me think that maybe that's a better comparison. For instance, I just was looking at, you know, revenue growth on average for those companies was about 12 to 15% and Roe was 20 to 30% IBM, great companies, yeah, and so it was just a simply great companies that people were massively overpaying for.

Larry Swedroe:

Here's the mistake that most people make, and there's no guarantee here. Okay, all of the research. Research that's been done over 60 years says this, that maybe one of the biggest mistakes investors make is they assume that abnormal earnings growth will persist for a long time. And fama and French did a famous study on this, I think, in 1998 and they found that abnormal earnings growth both positive and negative. So really bad earnings growth, they tend to revert to the mean at a rate of 40% per annum. So what do we mean? Just to help your audience understand this, let's say you know, companies are growing with the economy. Let's call it 6% a year, 3% growth, 3% inflation. Okay, so you're growing 6% earning and you're growing at 26 that's spectacular. So your abnormal earnings growth is 20. That means you should expect, on average, that instead of 20% abnormal growth, it'll be 12 the next year. So if the economy continued to grow at that six, you're now going to grow at 18, not 26 and the next year, it'll drop by 40% again. Now there are the rare companies like Nvidia that you know continue to grow earnings more rapidly, and that's why we see 4% of all the stocks account for 100% boiler is free, but good luck trying to find those 4% and be able to buy and hold them through that entire time and not buy and hold them like Xerox, which was the greatest company, maybe of all time in terms of innovation, right? And you know, they're the ones who invented what became Microsoft, for example. Most people don't know that, but you know, their labs out in Palo Alto, invented all that stuff, and they just sort of let gave it away. But anyway, you know,

Andrew Stotz:

research that you saw in that you were saying it's

Larry Swedroe:

farmer in French is paper? Okay? You can find it in my books somewhere. I've signed that. Yeah,

Andrew Stotz:

excellent. Well, but there's

Larry Swedroe:

there. I do remember the name because the title is great. It's called higgledy Higgledy Piggledy growth. And then there was a sequel called Higgledy Piggledy growth again. So if you Google those, you'll see this research was known back in the 60s that this kind of excessive abnormal growth does not persist. Now we know why. Logically, if you have abnormal growth, what's going to happen? It's going to track competition that wants to get at that abnormal growth. And when you have really bad earnings in industries, what happens? Supply disappears, companies go bankrupt, plants get shot, and then supply shrinks, and then profitability can be restored.

Andrew Stotz:

Oh, so much to talk about. Well, Larry, I want to thank you for another great discussion about creating, growing and protecting our wealth, and I'm looking forward to the next chapter, and the next chapter is framing the problem. Made me think about the great song by Alex Harvey called I've been framed that he sang. I don't know if he wrote it, but and then in this you say, in other words, you've been framed. So listeners out there who want to follow up with Larry, he's got so much going on. In fact, on Twitter, we were just talking about the release of an interesting mash up of a series of podcasts, I think is what you were saying. And so just follow him on Twitter at Larry swedro, and you're going to find a wealth of knowledge. He also is on LinkedIn. So just go there. This is your worst podcast host, Andrew Stotz saying, I'll see you on the upside. You.

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