What I learned about risk from “A Wealth of Common Sense”

Sep 27th, 2020
Personal finance

A Wealth of Common Sense is a friendly, easy to read investment book for the layperson. I tend to agree with the idea of investing passively and diversifying through ETFs that the book promotes. In part because it is well backed by research, and in part because it fits in with my worldview. I know investment management is a difficult skill, and I’m not intent on doing it full time, so I’d rather leave it to the pros.

That being said, my main takeaway was the reason why it’s standard advice to use stocks for long term growth and bonds to manage risk.

Stocks will grow more over time (or at least they have historically), but their prices will swing more significantly, so the risk you’re taking when you invest in a diversified stock portfolio is the risk that you might need your money and have to take it out while the stock market is down, realizing the losses.

Bonds tend to have lower returns but are more stable in price (investment-grade bonds that is), so they are useful for shorter-term investments or when you want to save for a shorter-term goal because there is less risk that your investment will be down when you need to take it out.

Taking this idea to a retirement portfolio, you can understand why it makes sense to hold more stocks early in your career and gradually shift to bonds as your retirement approaches.

Deep down, there is a risk that the whole economy will go south, and the stock markets will stop returning solidly over the long term, and I can imagine that risk is not zero, but I think there is little we can do against that with an investment portfolio. I plan on managing that by staying up to date professionally and learning to live a simpler life if I have to.

There is a lot more in the book, and I really recommend picking it up.

Any corrections, comments, ideas or suggestions? Email me at santiago@perezperret.com. You can also subscribe here.