Enrich Your Future 22: Some Risks Are Not Worth Taking

Update: 2025-01-13

Description

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 22: Some Risks are Not Worth Taking.

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.