Before I show you the 20-year annualized returns by asset class between 1999 – 2018, I want you to guess the following four things:

1) Of the following asset classes, the S&P 500, a 60/40 stock/bond portfolio, Bonds, a 40/60 stock/bond portfolio, REITs, Gold, Oil, EAFE (Europe, Asia, Far East), national real estate, which performed best?

2) What was the annualized return for the best performing asset class +/-0.5%?

3) What was the annualized return for the worst performing asset class +/- 0.5%?

4) What was the annualized return for the average active investor +/- 0.2%?

If you can guess two out of the four correctly, I’ll give you a gold star and might even take your child’s SAT or ACT exam for you.

If you only get one out of four right, you need to go run five miles immediately. If you get zero right, then you need to run five miles, do 100 sit-ups, and 100 push-ups.

There’s no way any of you are getting four out of four right.

Now that we have a deal, let’s take a look at the results to see how reality compares with your biased beliefs.

One of the things I’m fascinated about is why some people get upset with what other people do with their money.

Every time I write in my newsletter that I’ve decided to increase or decrease risk with my investments, someone gets hot and bothered!

What someone does with their money has no bearing on what happens with your money. You have the freedom to make one giant paper money statue and light it on fire if you wish.

I choose to consciously have a purpose for all of my investments. Otherwise, there’s no point to saving and investing so much all these years. I feel sorry for folks who’ve already reached financial independence and still can’t stop hoarding money.

Let me go through some examples of market timing everybody makes, but somehow don’t get recognized. I’m certain by the time you finish reading this article you’ll find more purpose with your money.

This post is for someone who is wondering:

• Whether they have the proper asset allocation
• How to reduce investment stress while still benefitting from returns
• How to quantify their risk tolerance
• How to continue moving forward on their path to financial freedom despite all the uncertainty

One of my primary goals on Financial Samurai is to help readers build meaningful wealth in a risk-appropriate manner. Because I started my career soon after the 1997 Asian Financial Crisis, I’ve experienced a lot of carnage as many international college students in the US had to drop out due to a sudden and massive devaluation of their respective home country’s currencies. I fully appreciate how hazardous the road to building great wealth can be.

Even the best-made plans can be laid to waste due to some unforeseen exogenous variable. We always hope for good surprises along the way. Unfortunately, life always has a way of kicking us in the face after knocking us in the teeth. Let’s always be thankful for what we have and demonstrate kindness to those who are experiencing difficult times.

Most investors overestimate their risk tolerance, especially investors who’ve only been investing with significant capital since 2009. Once the losses start piling up, it’s not only the melancholy of losing money that starts getting to you, it’s the growing fear that your job might also be at risk.

You might also erroneously think that the richer you get, the higher your risk tolerance. After all, the more money you have, the bigger your buffer. This is a fallacy because the more money you have, the larger your potential loss. For most rational people, their lifestyles don’t inflate commensurately with their wealth. This is why even rich people can’t resist a free rubber chicken lunch.

Further, there will come a time when your investment returns have a larger impact on your net worth than your earnings. As a result, the richer you are, the more dismayed you will be to lose money. Your main hope for recovery is a rebound in investment performance because your work earnings won’t contribute much at all.

Hopefully, everybody has been building a CD Step Stool or a Bond Step Stool (not a ladder) in this rising interest rate environment. A Step Stool is the smarter approach because the short end of the yield curve has been rising faster than the long end.

The Fed Funds rate is the shortest of the short end, given it is the overnight interbank lending rate. The idea is that the more the Fed Funds rate increases, the higher yields should rise for longer duration lending rates due to the time value of money.

But the market controls longer term lending rates, and the market is currently telling the Fed to bugger off. Investors have found comfort in longer term bonds because their risk appetite has diminished. They don’t see inflation on the horizon nor do they see rosy good times.

To understand why buying shorter duration bonds and certificates of deposits is the optimal financial move for your cash, let’s take a look at a simple bond yield table.

There’s a lot of uncertainty as we head into 2019. The Fed is expected to raise rates another two to four times. We’ve got a slowing housing market thanks to rising rates, rising inventory, and lower overall affordability. We also have constant geopolitical risk that never seems to go away.

As investors, we must properly forecast the future AND put our money where our forecasts are. To just forecast while taking no risk is like wanting to go straight to the corner office without putting in any work – it makes no sense!

I’m guessing one of the reasons why you enjoy reading Financial Samurai is that I’m not just pontificating about investing. I’m actively trying to build my net worth to live a middle class lifestyle in an expensive city. Sometimes I strike out. Sometimes I hit a home run. Hopefully, through self-reflection and through community feedback, we can make better investment decisions.

To get savvier, let’s look at what some of the top Wall Street strategists are forecasting for the S&P 500 in 2019. These folks spend 50 – 70 hours a week thinking about the stock market, writing research, and speaking to the largest money managers in the world. Surely, they know more than the average retail investors.

There are just a couple caveats. One, they aren’t putting their own money at risk or managing money for others. Two, they love to hedge their forecasts because that’s how they earn Managing Director-level compensation which starts at $400,000 a year in base salary and they regularly receive $500,000 – $3,000,000 year-end bonuses, especially if they can get their forecasts right.

Liquidity is overrated. Once you have about six months worth of living expenses saved, there’s really no need to hoard even more cash since you have insurance. If you do accumulate more cash, that’s called “cash drag” because cash returns have underperformed assets such as stocks, bonds, and real estate since the beginning of our financial markets.

Once you identify a trend, your goal should be to buy assets that benefit from that trend, and hold on for as long as possible. Of course, if you think an impending bear market is on the horizon, holding more cash is good. However, over the long-term, having too much liquidity I argue is a detriment.

When I first came to San Francisco in 2001 from Manhattan, I discovered that San Francisco property was so cheap compared to Manhattan property, yet wages were quite similar. Consequently, I bought all the real estate my salary could afford in 2003, 2005, and 2014, and held on for as long as possible.

Now, I foresee a similar long-term trend happening in the heartland of America because San Francisco and other coastal cities have gotten too expensive and technology makes living in a congested area while paying $4,500/month for rent, unnecessary and obsolete. Companies located in high cost of living areas can’t comfortably afford to hire workers, and the workers can’t comfortably afford to save for retirement and raise a family.

Every single one of my biggest investment wins has occurred because I waited 10 years or longer before selling. There was only one stock that I made an enormous return in just six months, but that was dotcom bubble luck. On the other hand, there are plenty of stocks I lost tons of money on because I got shaken out way too early. If I had held on, I would have been much better off.