Being wealthy doesn't mean having all the money in the world, just not having to worry about it.

Lesson 18 – Relax, You’re Going to Die

Over the long term, the survival of the entire global economy almost certainly depends on the continued profitability of the companies which provide the world’s goods and services. Without that, the tax base on which governments rely virtually disappears, lenders to those businesses don’t get repaid, and even that hedge against global disaster, gold, won’t be able to buy much because there won’t be much of anything to buy.

The point is this: you can’t insure against a long-term collapse in society. And if you want ultimate security, you’re not going to find it in your investments. Most importantly, you’re going to die someday. Or, at least, your current body is. You only get to take your Karma with you.
Obviously, I’m an advocate of patient investment in a globally diversified portfolio of profitable businesses as the most likely route to both long-term returns and long-term safety. It is possible to reduce the volatility of such a portfolio through the purchase of assets that will do well, or at least not as badly, during a global bear market in stocks. It is also possible to reduce the volatility through the use of market-timing strategies. However,

  • Virtually all attempts to reduce volatility below the level of a globally diversified equity portfolio should be expected to also reduce run returns, and
  • Reducing your long-run returns merely to obtain a somewhat smoother ride during your investment years is probably not worth the cost.

I’m not denying that stocks are volatile, nor can I guarantee that there WON’T be a permanent global collapse. I’m saying that volatility is probably not worth reducing if it comes at the price of a much lower level of wealth and that a permanent decline in stocks would also be devastating to virtually all other investments.

OK, it’s all well and good for me to keep harping on the long term. But what if you’re retired (or near retirement) and can’t necessarily wait for the “long run?” Or what if the investments are to cover the college expenses of your high schooler? In such cases, reducing volatility may be worthwhile (although eliminating it completely probably isn’t.) And what if you’re a panicky individual (or are partnered with a panicky individual) and suspect that you would not be able to handle a 50% decline in your investments without becoming suicidal (or homicidal toward me), with a serious risk that you would bail out at the bottom of the market? After all, if it’s legitimate to spend money on pain relievers and psychiatrists, what’s wrong with spending a bit of money on panic insurance?

Nothing’s wrong with it. So if we agree that volatility reduction is a consumption good for which you are willing to pay in the form of reduced returns, and if we agree that short-term spending needs may force you to trade growth for stability, we can continue on the same page. Actually, we can continue on the next lesson.