Wednesday, January 19, 2011

Personal Financial Fears

The more experience I get with personal finance, the more I realize that I fear different things than most people fear. Investing and mortgages illustrate these differences.


Almost all personal finance gurus recommend that investors put some fraction of their long-term savings into bonds or some other fixed-income investment. The reason for this isn’t because it will produce better long-term results than an all-stock portfolio. The reason is to prevent investors from panicking and selling stocks at low prices.

It could be that these gurus are right. If most people would sell at the worst possible time then owning stocks is a bad idea. If owning some bonds is enough to moderate the extreme losses enough that investors sit tight through the bad times then owning some bonds is a good idea.

But I don’t fear bear markets for stocks. I’m content to receive whatever the stock market will give me over the long term. When I think I’m 3 years away from permanent retirement I’ll shift a fraction of my savings into safer investments. The actual time I choose to retire permanently is likely to be affected by how well my stocks perform over the years.


I’m much more afraid of debt than I am afraid of stock market volatility. The recent mortgage rule changes that push people from 35-year to 30-year amortizations would never have made any difference to me. My first mortgage had a 15-year amortization and I was scared to death to owe so much money for so long. I ended up paying it off in 4 years.

The idea of trying to consistently hold a job that pays enough to make mortgage payments for 30 years seems crazy to me. But from what I can tell, people who take out these long mortgages are quite calm about it all.


My best guess is that the uncertainty in the investing case drives fear in most people, while the mortgage payments are quite certain. But it was the certainty of having to come up with the mortgage payment for hundreds of months in a row that scared me.


  1. Interesting take. I think being more worried by downsides that are certain makes a great deal of sense, but are you sure you're not underweighting uncertainty?

    The Nikkei peaked at 38000, and is currently about 10000. Following a stocks for the long run strategy in Japan over the last 20 years would have been a disaster. I don't think anyone expects this to happen here, but it's well within the range of outcomes that it is reasonable to consider. How would you look back on an all equity strategy if the TSX is at 4000 in 2030? Are you sure your strategy protects you against known risks?

    What about tail risk, particularly as it pertains to liquidity? I'm thinking of very low likelihood events. What if your house burns down, and for some reason insurance won't pay, and the market just crashed? Bonds don't just stabilize a portfolio against emotional decisions, they stabilize a portfolio against unpredicted events.

    I'm not saying your plan is bad. I'm just wondering if you've taken these issues into account?

  2. @Matt: The history of the Nikkei is a good lesson for not concentrating one's investments in one small part of the world. If the TSX drops to 4000, I will still have investments in other parts of the world.

    This brings us to the possibility of a multi-decade world-wide decline in stocks. Do you really believe that in such a scenario bonds would be worth much? With businesses failing, who would be paying taxes to fund bond interest payments? I don't believe there is anywhere to hide financially if the world's businesses fail.

    Another possibility is that businesses world-wide get valued insanely highly the way they were on the Nikkei in the past. In such a scenario, the businesses might continue to grow modestly but have their valuations reduced drastically. In such a scenario, I'd see my stocks rise in value by say 5 times and then return back to earth. I would be fine if this happened, but I must admit that I might be tempted to sell off some of my holdings as the world-wide P/E hit 50 and kept growing.

  3. @Cynical Investor: Buy and hold is not dead. The past decade in the U.S. bears little resemblance to to much more extreme events in Japan.

    It's important to focus on real returns rather than nominal returns. Viewed this way, the past decade in the U.S. is much less extreme when compared to past decades.

    1. The comment above is a reply to Cynical Investor's comment:

      Unfortunately it seems that buy and hold strategy is dead.

      I always think of Japan and now it happened to the US too (the lost decade as they called it).

  4. Interesting post. I have to say I fall more into the camp who worries about the stock market than my mortgage. I have an emergency fund to mitigate the risk of job loss. But I don't see a way to mitigate the risk of a poor stock return sequence around the start of retirement with a largely all-stock portfolio.

    I can imagine world stock valuations varying quite a bit over long periods of time, driven by how people feel about stocks more than how the world economy is functioning.

  5. @Blitzer: In my limited poll of people's feelings on these issues, I'd have to say that your reaction is more prevalent than mine by a long shot.

  6. I do agree with you -- I had a similar post a few days ago :)

    Of course, mine was also based on some active investor thinking (stocks are reasonably valued, Toronto houses not so much, with interest rates at record lows).

    Lost decades (or the even worse Japanese scenarios) are possible, but at my age I have several decades for things to work themselves out.

  7. @Potato: I think we're in the minority on this one. This doesn't concern me much though. Truth doesn't yield to democracy.

  8. When we first got our mortgage I felt grateful I could leverage my net worth by borrowing to buy a home. Now that the principal is low compared to my net worth, I'm eager to dispatch it.

    Paying it off in four years was a great achievement for you. Perhaps I was willing to tolerate ours for longer, since for a time our variable rate mortgage charged under 2% interest.

    I think people who are worried about an extended stock crash should focus on dividend investing. Having a decent cash flow from a stock might insulate it from drastic drops driven by market psychology (versus company-specific events).

  9. I'm with you. I hate the idea of debt so much that I've decided not even to buy a house at all!

  10. @Gene: I think you're right that focusing on dividends helps some investors relax about stock price swings.

    @Patrick: I suppose you could save up and pay cash for a house. But, I suspect you have other reasons for renting.

  11. @Michael: Yep, I'm all about saving up for things. One of my very first blog posts discussed this. (That post is not hypothetical. It's what we actually did. We just got our car this past August and paid cash.)

    You are right indeed, though, that debt isn't the only reason I'm renting.

  12. I can relate to this post, as I feel the same way. I paid cash for my home, and hold an all-equity portfolio. I too plan to decide my retirement date according to how the stock portfolio goes and perhaps reduce volatility when I am 3-5 years out. Hope it works!

  13. @Tara C: You don't hear about many people who pay cash for their homes. Well done.

  14. Recently I've found an interesting phrase for investors: Be fearful when others are greedy and greedy when others are fearful. Loved that.