The Main Types Of Investment Risk Exposure To Be Aware Of

The main types of risk exposure when investing

I'm not sure if homebuyers truly realize how much concentrated risk they are taking when they buy property. Most middle-class homeowners have a majority of their net worth in their primary residence (~80%). This can be dangerous during a downturn. Therefore, I want to use this post to discuss the main types of investment risk exposure to be aware of.

The appropriate amount of investment risk exposure will help you make money during a bull market and let you not freak out during a bear market. Matching your investment risk exposure to your true risk tolerance is vital for long-term wealth creation.

Investment Risk Exposure

I'm particularly concerned about first time buyers putting less than 20% down because they can't afford a larger downpayment. Given they can't put at least 20% down, it's likely they also don't have any meaningful investments in stocks, bonds, or private ventures.

In other words, they are all-in and then some with real estate. Always follow my 30/30/3 home buying rule. If you don't, you put your finances at tremendous risk during a bear market.

Just in case it's not obvious, mortgage debt is also considered investment risk exposure. You're basically leveraging up to make a concentrated bet on a single asset that hopefully goes up. If it goes down and you need to sell, you're screwed. 

During the global financial crisis in 2008-2009, the average American's net worth got destroyed because over 80% of the average American's net worth was in real estate.

Some people have asked why I wasn't in a bigger rush to reinvest 100% of my house sale proceeds (~$1.8M) in this market. If I did, I'd still have $815,000 less in risk exposure because I paid off the mortgage.

Why I Wasn't In A Rush To Reinvest My House Proceeds

The first reason why I wasn't in a rush to reinvest the proceeds is because it was a lot of money. I don't want to lose it. I redeployed about 60% over the first three months and took another five months to redeploy the rest.

The second reason is because I needed firepower just in case I found a sweet property deal during the winter. I didn't, but you just never know when opportunities show up.

For example, during the height of the lockdowns in April 2020, I found an amazing ocean-view property in San Francisco for a $200,000 discount. It is currently our forever home which we'll enjoy for at least ten years.

The final reason why I didn't rush to reinvest is because I still had roughly $1,000,000 in mortgage debt. Meaning that with a current cash balance of ~$900,000, I've already got Maximum Exposure + $100,000 in leverage to risk assets.

Years later, I paid off another rental property. After I did, I realized there is a triple benefit to paying off a mortgage that I didn't realize!

The Definition Of Maximum Investment Risk Exposure

Maximum Exposure is not just investing everything you have in risk assets like stocks and real estate. Having Maximum Exposure is investing everything you have in risk assets AND borrowing as much as possible to also invest in risk assets.

With real estate, banks will generally lend your household up to 5X your annual household gross income. With stocks, brokerage accounts may let you borrow up to 50% the value of your stock holdings in the form of margin.

For the record, I'm not a fan of going on margin buying stocks or taking a HELOC out to buy risk assets. Stocks are much more risky than real estate. Stock value can lose 30%+ over night. Whereas real state is much more stable.

Historical chart of margin debt in the NYSE Stock Market
Source: Advisor Perspectives

When To Have Maximum Risk Exposure

The time to have Maximum Exposure to risk assets is when there is blood in the streets. That time period was most recently between 2009 – 2010. The problem is that nobody can properly time their Maximum Exposure to perfection. It can only be done in hindsight.

2023 also seems like a growing time to increase investment risk exposure given the S&P 500 declined by ~19% in 2022. However, the allure of owning Treasury bonds yielding 5%+ is hard to ignore.

Given perfect timing is impossible, one must raise and lower their exposure during a cycle. The long-term trend is luckily up and to the right. But the desire or ability to work is finite, and so is life itself. There's no point dying with boatloads of money, especially if it's going to be taxed at 40%.

Hence, eventually, you want to go into decumulation mode so you don't die with too much.

Maximum Investment Risk Exposure Pre-Financial Crisis

I did a reasonably good job getting Maximum Exposure from 2003 – 2007 with investments in stocks and two San Francisco properties and one Lake Tahoe property.

Total mortgage indebtedness was roughly $2,200,000 as a 27 – 30 year old. Then I went backwards for several years until the market started stabilizing in 2010, and ultimately recovering.

I wanted to de-risk by $1.1M in 2012 because I had just left my job, but nobody wanted to buy my property at the asking price. By the time 2014 rolled around, a 4.1% CD came due and I had the fire power to buy another property to gain Maximum Exposure again.

It's strange how quickly my mindset changed from de-risking to increasing risk in two years, but I decided to take on $1,000,000 more in debt to buy a fixer in Golden Gate Heights.

My online revenue was growing, my net worth had rebounded, and I strongly believed buying a panoramic ocean view home on both levels for $720/sqft was a no brainer.

The Definition Of Full Investment Risk Exposure

After selling my rental house, I reduced my investment risk exposure to Full Exposure. At the time, this is exactly what I wanted after a ~60% rise in San Francisco property prices since 2012, an ~82% rise in the S&P 500 since 2012, and a ~130% rise in the NASDAQ during the same time period.

Further, given my site's size and the fact that I'm still a one man band who now has fatherly responsibilities, I'm expecting online revenue growth to slow. As a retiree, I enjoy conservative returns and steady income.

Full Investment Risk Exposure Definition

Full Exposure is defined as investing all your cash flow and having all your assets tied up in risk assets plus a comfortable buffer. The comfortable buffer is up to each individual. Six to twelve months worth of living expenses is appropriate. For me, I like to have at least $100,000 in cash for emergencies or investment opportunities.

Full exposure also requires one not be leveraged to a risk asset, or have cash equal to the amount of mortgage or margin exposure. Given I have about the same amount of mortgage debt and cash, I'll further refine my definition and describe my exposure as Synthetic Full Exposure. Synthetic Full Exposure is less risky than Full Exposure due to having a large cash balance.

Because I'm not sure how long the bull market will last, I'm concurrently paying down mortgage debt and investing in stocks, bonds, and cheaper real estate investments around the country each month. The goal is that by the time a bear market arrives, I'll have less debt, additional gains in risk assets to buffer for a downturn, and plenty of cash to take advantage if things get really ugly.

The Definition Of Reduced Investment Risk Exposure

I define Reduced Exposure as investing less than 70% of your regular after tax, after all expenses income and having more than 30% of your net worth in risk-free assets like cash, CDs, treasuries, and municipal bonds.

Reduced Exposure is great leading up to a bear market and for at least the first year of a bear market. Eventually, you'll want to switch from reduced exposure to Full Exposure once there are indications that the bear market has bottomed.

Again, it's impossible to perfectly time the market. Therefore, it's important to do your best to manage your risk exposure at various points of the cycle. It's not bad to sell a little too soon or buy a little too early.

You don't want to be selling when everyone is selling, nor do you want to buy when everyone is buying. The herd mentality destroys pricing rationality.

I'm not in Reduced Exposure mode yet. But I'm getting close given high risk-free Treasury bond yields. 2021 did feel like 2007 again. Maybe the party will rebound by 2024.

Little-To-No Exposure = Investing FOMO

Main Types Of Investment Risk Exposures

You can have little-to-no exposure to risk assets, but that type of exposure will likely leave you bitter at life if you are not already financially independent because you'll have to work forever or experience endless envy towards those who bought a home or made a fortune in stocks or other risk assets.

Read any real estate section in any major city newspaper and you'll feel the angst of the writer talking about how unaffordable prices are. The same goes for the stock market section where journalists regularly make fun of the meteoric rise in certain stocks and cryptocurrencies. You can bet your bottom dollar all the authors have been left behind.

Don't get left behind.

In 20-40 years, your children will ask you why you didn't take advantage of today's low prices. It's why every parent should encourage their kids to earn money and contribute to a Roth IRA.

We all wish our parent's bought as much ocean view property and unhealthy McDonald's stock when they were young. My grandfather could have bought beach front land in Waikiki during the 40s for nothing, but he didn't want to be next to a butcher. Darn it.

Take Some Calculated Investment Risks

After you achieve your stretch net worth goal, you can't help but want to run up the score even more in a bull market. One reason why is because you know the bad times will eventually come again and you want as big of a buffer as possible. Another reason is simply because you can afford to take risk with money you didn't think you'd ever obtain.

To achieve financial freedom, more than half the battle is to simply have appropriate risk exposure for as long as possible. The exact type of exposure you have is secondary. Here's my recommended net worth allocation by age and work experience.

My hope is that everyone who reaches their stretch net worth goal uses the money to buy themselves time. Time is always running out. Money is infinite.

Real Estate Investing For Desirable Risk Exposure

Real estate is my favorite way to achieving financial freedom because it is a tangible asset that is less volatile, provides utility, and generates income. Stocks are fine, but stock yields are low and stocks are much more volatile. The -32% decline in March 2020 was the latest example. However, real estate held steady and appreciated in value then. 

I believe real estate provides the best combination of returns, lower volatility, and desirable risk exposure. Real wealth consists of real assets, not funny money like stocks.

Fundrise: A way for accredited and non-accredited investors to diversify into real estate through private eFunds. Fundrise has been around since 2012 and now manages over $3.5 billion for over 500,000 investors. The platform primarily invests in Sunbelt residential and industrial real estate where valuations are lower and yields are higher.

CrowdStreet: A way for accredited investors to invest in individual real estate opportunities mostly in 18-hour cities. 18-hour cities are secondary cities with lower valuations, higher rental yields, and potentially higher growth due to job growth and demographic trends. Just make sure to do extensive due diligence on every sponsor as you construct your select real estate portfolio.

I've personally invested $954,000 in real estate crowdfunding to take advantage of lower valuations in the heartland of America. My real estate investments account for roughly 50% of my current passive income of ~$300,000. 

Both platforms are sponsors of FS and FS is currently and investor in Fundrise funds.

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82 thoughts on “The Main Types Of Investment Risk Exposure To Be Aware Of”

  1. Hi, im 42. I have a debt to equity ratio of .35 (and debt to assets ratio of around .2) on 7 properties with 2 of them mortgaged, the rest already paid off. Im planning to sell one because its getting older. With that money i could payoff all debt but would lower my income base, or i could invest it in another, better, property, but would still have to take on another mortgage to buy it which would increase my ratio to .47

    Do you see a high exposure on this, given the times?


  2. I have $3 million sitting in cash. Crazy huh? My invested assets make me too anxious, the cash helps relieve anxiety.

    1. RetiredAt53

      That depends on total investable assets. If you are worth 100M, 3M cash might be a good reserve. If you have investable assets worth 3.5M, that would be different…

  3. Dood, el Farbe

    Hi Sam!

    I guess we’re at “full”. We have no debt. The house is maybe 10% of net worth, we have about 300K in cash, and the rest is invested in equities and equity funds.

    Looking just at the big chunk that’s in equities/equity funds, almost 70% of that value is in 401(k) accounts and deferred compensation accounts that I can move from fund to fund without realizing gains.

    Those are up about 25% overall YTD and I’m wondering (question for anyone reading) – if I want to reduce risk of loss in these tax-deferred accounts, assuming the bear will return sometime by mid-next year, what are the best places to hide out from a bear market?

    All of these accounts offer one sort or another of a “target 2020” type fund, presumably lower risk, like VITWX which is about 50% equities, some cash, remainder bonds. But they also offer complete bond index funds like VBLLX or VBTIX (or “generic” versions similar to the Vanguard funds in some of the other 401(k) accounts).

    If someone decided to reduce risk of a potential coming bear market, are these bond index type of funds generally the safer haven in a stocks crash?


    1. Paper Tiger

      How old are you and how far away are you from retirement? You have several options you should be considering if you are less than 5 years away. If you have a much longer time horizon then the scenarios and options are different.

      1. Dood, el Farbe

        Hiya Paper Tiger, thanks for checking in. I am 52 and want to retire next year or year after (either is doable, but a certain amount of benefit depends on the “as-of-then” valuation of company stock options).

        But my main interest is just in protecting current gains (which to me are significant) from a coming bear market, whether I am interested in retiring next year or 20 years hence.

        Just trying to figure out what is the investment that is the least reactive to an equities bear market. Suspect the answer is to go fully bonds, but would like to hear opposing arguments.

        Thanks again.

        1. Dood, el Farbe

          P.S. I should reiterate that these are tax-deferred plans and while I have a number of investment options (like the mentioned “2020” plans and bond type index funds, simply moving to “cash” is not an available option).

        2. RetiredAt53

          Bond pricing and bond funds react to interest rates with the swing inversely proportional to interest rates. The longer duration the bond the larger the swing. So, if you think interest rates are staying the same or dropping, bonds will increase or flat with interest. If ya buy and hold the bonds to maturity you do not have this problem.

          Sequence risk is a big concern in ER, if you have the cash or income to not draw down portfolio during early large losses, ya have great chance of making it using 4%, if ya have to pull from portfolio while down significantly, success may not be as easy.

          Your cash position covers how many years of expenses?
          Any other income?

          These would reduce my concern and need to time… with that said, I like synthetic indexing the market with options…

        3. With 70% in Deferred accounts, you might want to sit down with a retirement planner or CPA and seriously consider moving some of your money into a Roth IRA. Pay the taxes on it now and have tax free income for the rest of your life that can also be passed on to heirs and remain tax free for them as well.

          Not sure what your other income streams are but if they won’t fully cover your retirement expenses you could do some calculations to determine how much you might consider rolling over and what returns you would need from that to cover your gap and then develop an investment strategy for that money to generate those returns.

          I’m going through this exercise now and realizing how much taxes will come out over time, even if I wait for RMDs to hit. There are advantages to addressing the tax issue for your deferred accounts now vs. waiting. How much you should convert is a matter of individual circumstances and goals.

          1. Dood, el Farbe

            Thanks Paper Tiger. Your reply wasn’t visible when I replied to R@53, but some of what I replied there goes to your comment.

            You also give some good food for thought on rollover-then-Roth conversion.

            But I haven’t given it much consideration as yet because I’m trying my darndest to avoid as much tax as possible right now by shoving over half of my compensation into the deferred account… if I did a roll and convert of one of the old 401(k) plans it’d be mostly at 39.6. Ug. Uncle Sugar likes his Sugar.

        4. Dood, el Farbe

          Thanks RetiredAt53. Current cash is maybe a 2.5 year float, but I’ll also have several more years’ worth on hand once I retire; much of that’ll be invested, likely. We do burn a lot of cash: family of 6 in a moderate COL area (135 on the 100-scale) and 4 to put through college, graduating in 2021, `22, `24 and `27.

          Besides the cash I’ll have quarterly income for the first 10 years in retirement (above mentioned def.comp. account). My wife is younger and wants to work ~ 6-10 years after I retire and makes close to 70% of what I’ll be getting those years. We’ve got some smaller dividend-focused accounts that make about $20K a year. Anyway, combined the income should be more than we need even in the years we have 3 kids in college at the same time. So I doubt we’d need to touch the cash, and certainly not have to draw down investments, and instead expect we’ll continue to save additional money during these 10 years.

          That’s the main reason I’m starting to get focused on shielding the def.comp. account from a stock market downturn/correction/crash, given it’ll be our largest income source in the first decade of retirement.

          The several 401(k) accounts are less of a worry, since they’ll have more time to recover before we need them, but I’d like to shield them to the extent possible as well.

          The taxable stock accounts I don’t want to mess with very much because for the “growth” stocks I’d like to avoid realizing the gains and associated taxes, and those that aren’t “growth” stocks are mainly for dividends.

  4. I am 60 and our investment portfolio is currently at full exposure. Our breakdown is Equities-85%, Bonds- 4% and Cash & Cash Equivalents- 11%. If you look at these as a percentage of our Net Worth which includes home equity and personal belongings/collectibles, it is Equities- 69%, Home Equity- 14%, Cash & Cash Equivalents- 9%, Bonds- 4% and Personal/Collectibles- 4%. Our mix of investments is 54% tax-deferred and 46% non-deferred.

    We are currently working with a retirement planner and our CPA to consider converting deferred investments to a Roth IRA, simplifying our investments and dialing back some of the risk without sacrificing much of the projected returns. Our only long-term debt is our mortgage which still has 7 years @ 3.5%. We are FI but still working, with plans to fully retire sometime over the next 5-7 years. Too many variables to get into the details but we can pull the plug anytime we want and be financially secure for the rest of our lives as long as we don’t do anything stupid ;)

      1. Paper Tiger

        I had a 36-year career in healthcare sales and leadership roles, specifically medical devices. My wife is also in the same industry but she is 4 years younger than me and still really enjoys what she is doing.

        My motivation is to help improve a healthcare system for seniors and the chronically ill and their families, who are woefully underserved. Two years ago I retired from the corporate world and helped co-found a company to try and make a difference. Our startup works with both providers and payers on better solutions and improvements in this area of healthcare using mobile device technology and process re-engineering around care coordination. I guess you would call this our “give back” strategy to an industry that has provided a great life for me and my family.

        I have no idea if we will be successful but working this opportunity and continuing to engage as an advisor and mentor to other healthcare startups just seems like a worthy plan that could even continue on a part-time basis in retirement to keep us feeling vital and needed. We will make time to enjoy what we’ve worked hard for but I also want to feel like we can still make a difference and help others, even in retirement.

  5. Middle Aged Investory

    Hi Sam, Great article as usual. I too would also like to see an article on preparing for a bear market. As a middle age investor, I have a mix of almost equal percentage of equities, bonds, REITS, and MLPs. I still have a mortgage, since over the cycle of this home purchase it is my worst performing asset (time period 22 years since acquisition in the great mid-west). I understand the positions others have taken to pay off mortgage debt, but I would have a lot less wealth if I had done that at this point with funds that I have invested over the same period. My last child started engineering school this fall, so I still have large college expenses to deal with, at least for the next 4 years.

    I max out my 401k, don’t acquire debt, and try to stay well diversified. I have about 10% of cash assets available at any one time. When the 2008 downturn happened, many of my colleagues moved their 401k’s into all cash. I stayed steady and rode it out and my patience is paying literal dividends today.

    Life lesson here is “Keep your head when everyone else around you is losing theirs”.

  6. Great post, thanks.

    With the bull market raging onwards, most investments being up and showing positive returns it’s natural to look towards the next bear market. This appears to be contemplated in your piece.

    I would be interested in a follow up article which outlines; how to prepare for a bear market and possible strategies once it arrives.

    For instance, I am paying down mortgage debt, remodelling my home and not reinvesting dividends. If a bear market / recession were to arrive, I have a plan.

    1. If you are worried about current valuations and/or how high Mr. Market can go, here’s a nice, topic to discuss…

      Start going to cash, find a long term CD that pays 2.5%, or toss into Savings Bonds, hold for 20 get 4%. With the proceeds buy S&P500 options. With 100K, you can use the $2500 – $4000 interest, depending on your risk free choice to purchase Dec 2018 265 options for 1400 each. Two will cost ya $2800 and you’ll have a 53% participation ratio, buy a third for a total of $4200 and sell 2, Dec 2018 295’s for $200 credit each. You’ll have a 78% participation ratio up to 295 (11%) and 26% participation ratio above that and it will cost $3800 of your interest.

      If the market tanks, you lost the interest on your money and very little of if any of the principle. If Mr. Market keeps going up, you get a nice percentage of the gain designed at your comfort level with (almost) none of the risk.

        1. RetiredAt53

          Thanks Sam. The challenge is finding a decent risk free rate of return in today’s environment. This is how the Equity Indexed Life insurance products work, but without the fees.

          Thinking past the possibility of 100% loss on the options is challenging for some. As a package, the loss is hidden. Once you wrap your head around it, it’s powerful.

        2. Since my knowledge of options is limited, is the safety factor here?:

          1) Using only the 3-4% CD/bond interest/return to “gamble”
          2) If price on stock goes up, great, you sell and make money
          3) If price goes down, your ONLY risk is the money you spent buying options (which was “house” money anyway)?

          1. If your options don’t close in the money, you basically lose your entire principal. But since the money you are bidding on is the interest on your risk-free investment, you’re never really losing any principal.

            In other words, he is recommending swinging for the fences with your passive income.

          2. Jeff, Correct.
            Mental separation of the two piles of money causes confusion.

            We toss big money, $100K into a riskless pool that at the end of the year we are guaranteed to have $103K.

            We take $3K (you may have to find it somewhere, or use $97k above) and put into options on the S&P. Say 3 contracts. Contract=100 shares. SPY is at about 265. Mr. Market tanks and SPY goes to 200. You lost $3000 on the options, but gained $3000 in interest. You break even. If you had $100K in SPY and it went from 265 to 200, you would have, about $75K.

            If SPY goes to 290, you have 3 contracts (300 shares) that will be worth 290-265 = $25 each or $7500 + the 100K in the CD for $107500 or a gain of 7.5%. Whereas the $100K investment made in SPY without options would be worth about $109,400. You risked $3000 to be in the market at 75% without down side risk by accepting 75% of the upside gain.

  7. Hi Sam! In “welcome to euphoria”, you recommend that the readers don’t blow the current market opportunity. What does it mean?! (Specifically). Yes, we should sock as much as possible away and not be spending, but doesn’t max exposure to equities also give us max possible losses in this overheated market? Grateful for your thoughts. =)

    1. What sort of risk allocation to you think is appropriate for today’s market, probably 1 year out from a correction? :)

      1. Paper Tiger

        Jess, are you really worried about market “corrections” or the next market recession? Corrections are defined as a 10% drop from the prevailing 52 week high. Those are fairly common and occur at an average of a little over twice per year. As you know, corrections are actually healthy in markets like we have today where inflation is tame and interest rates remain low. During this time, corrections give a market a healthy breather in which to continue to build upon the next leg of the bull run.

        Crashes occur when there is a 10% drop in one day and if followed by another 10% or more drop in subsequent days or weeks, you have now entered a defined bear market. Crashes can lead to a recession if companies begin to reduce investment and initiate layoffs and other measures of retrenchment until the market environment for investment improves.

        In my opinion, if the tax bill passes today in the Senate and we ultimately get a bill for the President to sign, the environment for business and the markets will be even more favorable so any corrections in the short run will be viewed as healthy breaks into the next leg up of this secular bull market. I think the biggest risk out there right now would be political and geopolitical in nature, i.e. Trump gets impeached, N. Korea fires off a nuclear warhead, etc. If you think the odds are high for something like this then you should be hedging your portfolio accordingly. Otherwise, keep your assets well diversified and in accordance with your risk tolerance and you should be fine for now. If you have a long time horizon, I wouldn’t be compelled to make any significant short-term tweaks at this point, given the current favorable market environment.

        1. Thanks Sam! I’m encouraged and convinced by this view. Of course – I like returns. The market just seems … eerie. Maybe I will diversify my high risk assets across stocks, property and cryptocurrency instead of holding anything low return. Lol. I’m partial to the view that if you have a long horizon, going all equities will be work out better in the long run than a large low-yield-but-safe allocation.

          1. The longer your viewpoint, the easier it is to invest. My period from the newsletter is to know where you stand in each point of the cycle. I was one of the easiest time to get rich, and go broke. There are so many variables in your life that Only you can decide what is best for your financial future. For me, I want lots of cash while also having full exposure because these bull markets tend to go longer than anybody expects.

            1. Yes I like that – keep full exposure with full knowledge that it might drop off in 1 year, but thats ok bc it is a long term play, and keep cash to be ready. :) Is that your thinking? I”ll also rent my current 3bdr so I have some reliable cash flow just in case.
              I think your perspective in the email was unique – thanks for it!

  8. NativeTexan

    I read these posts and can’t help but think that most of you are very optimistic about the future of America and middle-class Americans. I am retired, close to 70 (as is my husband), and we have been able to acquire more assets than we dreamed possible when we married more than 40 years ago.

    We both feel that America because of the current political/social climate is on a precipice and likely to topple over at any time. (Right now I am hearing the news that Flynn is being charged in the Muhler investigation and likely that development will cause further charges to other people.) In a system that ignores historical evidence that “trickle-down” economics do NOT work to general economic growth, how can you expect to see demographics perform in the way you expect.

    I forsee a return to Medievalism with multi-national corporations and uber-wealthy individuals operating like walled-city states in Italy with a huge class of serfs allied to some “noble” house trying to eak out a living and a few resilient guilds and trades trying to maximize their skills and options amid the larger forces that control their world’s sphere. Many people already fall into the serf-class since they are basically wage-slaves while a certain class of tech people, medical providers, artists and small business owners might be considered guilds with their special hierarchy of admittance and necessity to the city-states’ economies…
    Even the Medicis needed a Leonardo…

    We are probably in position to take advantage of market downturns since we have cash to invest on the downside–but is that just going to be catching a falling knife in retrospect? Are none of you worried about the risk of climate change with the rising sea levels and areas of drought in farmlands — are do you just consider those ephemeral statistics?

    We have seen a rising stock market because certain factors in American society and economy have existed since the days of colonization by Europeans… But I am not sure that those factors are set in stone and resist any attempts to change them. I hope this is not too political—but I would appreciate knowing how you find optimism in what I view as a dire future for my adult children and grandson–even if it doesn’t really impact me.

    1. NativeTexan, I think you articulate a lot of relevant points and risks to the market but my view is this is not the overall behavior of the market or the trend of future opportunities; these are simply the risks that will make the ride bumpier but the overall trend continues to be up.

      I think we continue to be in a classic secular bull market and maybe somewhere in the first 1/3 to the first half of its overall run, which means we could still have an “up” trend in the US for another 10-15 years. I believe this trend will be led by technology, innovation, and productivity making great leaps during this time. It will enable population growth and increased immigration as more people see job opportunities increase, particularly as we are turning over an aging and retiring baby boomer population and the need for more workers to replace those jobs and pay taxes to support all of these retirees and their social security benefits and Medicare healthcare costs.

      As others have pointed out, we will have a considerable infrastructure and defense investment in this country yet to be made and the same in healthcare. I also believe our economy is in the early stages of a significant rebound and continuing prosperity, and while inflation will kick in as a result, it can be managed in order to maintain an environment that is accommodative to future growth.

      Clearly, there will be risks, not only the ones you mention but geopolitical risk as well. But my feelings are that the US is still the best game in town and remains that way for the foreseeable future.

    2. Financially you have to be an optimist with a big foot note that Sam and others have mentioned: the ability to ride out a recession or job loss. I am in this position. I do think it’s prudent to be pessimistic in other areas of life perhaps about earth quake in CA, or whatever history recycles because this helps me prepare. Usury the media promotes in the form of fear has been helpful for my investments. For example in my lifetime the media has told me to worry about Communist, Cold War, Vietnam, AIDS, Iraq, Y2K, SARS, Iraq, Afghanistan, Ebola, and now its terrorism and N. Korea. I forgot to mention the killer bees where going to consume the USA by 2000 ( I asked for a mosquito net one birthday and years later used it to go fishing). I didn’t listen and all of it has been tragic but also hype at least financially. America has survived countless wars, depressions, recessions, assassinations, and serious civil unrest, etc. I will always bet it will continue to do well financially, because there is no better choice, but again my net worth is high enough to survive in bear markets. I think the biggest issue in the world is no surprise, the depopulations of China, Japan, Korea, and lesser extent Europe. The media hardly mentions this, but this may help Africa, India, and ASEAN rise, but the safer bet for me is the USA. Should I have a 2nd passport? Most of my close friends do. Should I not financially worry about anything reported by the news?

    3. Sure, my optimism lies in the fact that you guys have accumulated more assets and more wealth than you could’ve dreamed that Wealth will be passed on to your children and grandchildren.

      They are very lucky to have you guys!

      So many of my neighbors are adult children who didn’t have to buy their homes and don’t have to pay rent. They live wonderful lives, full of leisure and low stress.


  9. Ms. Conviviality

    I think I’m a full-max hybrid. We took out max loans to invest in worthy opportunities that are providing returns of ~25%. We didn’t take out a HELOC on our mortgage free home though and we have a cash buffer. I think I’m trying to make up for all those years when I didn’t invest in anything. It’s amazing how our net worth has increased just by constantly coming up with ways to make money.

  10. Hi, Sam: You got an excellent article on risks & investments: i found most people tend to conflate both, and as a result, are not able to make good decisions on either one.

    First of all, the risk most people talk about are investment risks, yet the risks that are most *relevant* is actually job risks. To be more specific: if i lose my job and not able to find income replacement in N years, that’s the risks most people should concern with. If you can eliminate this risk, then the so-called investment risks is not even an issue: S&P returns 6% “in the long run”, so as long as you’re never forced to sell (due to job risks), and can be happy with 6% return, then there’s no risk there.

    To eliminate job risk is simple: keep N years worth of living expense in cash, and make sure you have employable skills. The issue of whether to keep a mortgage and invest in S&P then became trivial, since you’ll never be forced to sell S&P.

    Like Warren Buffett said, you have to survive before you can prosper.

    1. You make an excellent point about survival and taking more risks once you know you will survive.

      I have found that after certain point, I can’t seem to get myself to take more risks. Maybe it’s because I took the greatest risk of them all, which is to exit the workforce age 34. And now that I have a son, I am hesitant to take more risk as well.

      Seriously, after you decide not to have a job and to survive with your own two hands, there is no greater risk. But at the same time, there could be much more upside.

  11. Everyone seems to believe Cash Is Trash, but cash in the form of savings, money market, CDs, and short-term U.S. Treasury offer a pretty reasonable rate of return (around 2%) for the security and liquidity you get. Not sure why people feel the need to be 100% invested in risk assets, 100% of the time.

    1. Rudiger, $10M at 2% over 223 years = $1 trillion. I don’t disagree with you but you better live in Ohio if your capital is low, or have maybe 10M. Someone said success is sleeping well at night. I don’t because I am home with the flu, thus all these post, but I’m starting to feel better… and this has been fun.

  12. I love the optimism on the U.S. I still think it is important to have international diversification. Demographics and, even GDP, have been proven to be poor indicators of stock performance. If they were our markets in the US would have returned not much more than 2% per year over the last 5 years. I have no idea what will happen in the future. I can only say that when you look at very long term trends on investing, there is a reversion to the mean. For me, that indicates that Emerging Markets will not perpetually underperform on a rolling 10 year basis forever. That is why I overweight that segment by 2%.

    I apply that vision to interest rates as well. We are in the second longest period of low/declining interest rates since data has been available – all the way back to the Italian city states of the 15 century. The implication for investment for me is that I am avoiding bonds almost completely. I synthesize that with a GIC in a large 401K I have that pays 2% with a stable value. Good enough for me. Rates will turn and if history holds it will be fast. However, when that will happen in unknowable.

    Again, I stress the importance of developing a personal investment policy. Just live by the rules you have made up and you will be fine in the end.

    1. rutleyh, the loss of population in China is a profound indicator of its future stock performance due to coming massive labor shortages. Will Africa’s exploding young population save the day? It is more than demographics. It is a tragedy as significant as European cities leveled in WW2, or the black plague. What will compound the problem is China is now encouraging fertility. Currently there are 30 million men who cannot marry. Diversification in China, Japan, Korea, and to a lesser degree in Europe due to immigration is diversification in a ship taking on water. I prefer lower hanging fruit, like real estate in the South vs the Midwest. Prescott, AZ (still undervalued) Vs Detroit (overvalued). That house for free in Detroit is appropriately priced. Michigan’s population is declining, and the baby boomers are moving. One thing that could save Michigan is immigration, but why bother when the baby boomers I think are a safer bet. This is getting into the details, my point is why would I be in China with a 500 million decline in population in next 30 years even if they can turn it around with African labor, no thanks.

      1. Max – except there is no evidence to prove that point. In the prior century the GDP for the U.S. was double that of the U.K. yet there stock returns were virtually the same over the long run? Why? Because the things you mentioned do NOT correlate to stock market returns. The only 2 factors that appear to have any predictive value in any sense in regards to future stock market returns are standard p/e ratio and Schiller p/e. Even those are only around .43 correlative. It is the entry point that matters. The studies are out there that prove this point. Sorry, but I go with what the data says.

        Remember what John Templeton said, “find the biggest disaster and invest in it. That is how fortunes are built”.

      2. Max – I would avoid Japanese debt based on demographic information. The simple fact is that they own virtually all of their gov debt but will default based on the simple fact they don’t have enough new population to buy the debt. So, they will have to issue debt with much higher rates at some point to entice people to buy. Anyway, I just look at things much differently based on data. The data that you suggest correlates to stock market returns has been shown to not correlate at all.

  13. This was great! I’m sitting right at the edge of full/reduced exposure (30% bonds + cash buffer) just based on my conservative asset allocation model which is highly individualized.

    At the end of each month I manually input all of my accounts into a spreadsheet and reflect on it based on a lot of these factors.

    Highly recommended habit and it’s so validating to watch it grow (knock on wood!) over time.

  14. Recovering Engineer

    We are at slightly different stages in life but I find the dramatic difference in our asset allocations to be interesting. Given valuations abroad compared to valuations in the US is there a reason you have almost no international allocation? (my PC screenshot)

    Technically I’m at reduced exposure but only because I’m sitting on cash to buy a house and remodel in the next few months. Once that happens I’ll be at Full or maybe Max exposure. I’m not thrilled with prices today but rent is crazy here and I can get a 30-year fixed Jumbo loan at 3.375% so the math to buy a primary residence makes sense. I’m fully invested in the stock market but I have a decent sized short exposure as well which makes me more comfortable holding on to my longs at these prices and I am shifting to saving cash rather than allocating more to the markets (outside of my 401k contributions).

      1. Recovering Engineer

        Yep I guess that was a faulty assumption on my part. I know you’ve posted about building up your muni bond portfolio so while the allocation seemed strange it didn’t look out of the realm of possibility.

        I’m looking to buy in Westchester County. It will be my only real estate ownership (seriously kicking myself for selling my townhouse in Colorado 4.5 years ago) and our primary residence. The new tax bill will cost me a small fortune in increased ownership costs, particularly the Senate plan, but the math still works out. I’m escaping a 3.7% city income tax and my mortgage + property taxes will be cheaper than the rent on a comparable number of bedrooms in the city even if none of it is tax deductible. We are looking at somewhere around your “ideal mortgage” level although you are going to have to re-write that post if the tax bill passes. There will always be people wanting to leave NYC for the suburbs and a good school district so even if I don’t get price appreciation I’m not concerned with the bottom falling out and being upside down. Plus being in a good school district from the start means we won’t have to move again until we choose.

        1. Best of luck to you. That is a bummer that you sold in Colorado four and a half years ago. Hopefully used the proceeds to invest in the market?

          I know already that I will be kicking myself in 20 years for having sold my rental property today in San Francisco. But as of right now, I feel blessed to have a buyer take the property off my hands for 30 times gross rent so I can focus More time raising my son. The stress really got to me.

          1. Recovering Engineer

            I invested the proceeds in a degree. Hindsight being 20/20 I should have taken out more student loans and kept the property. However I would have had to hire a property manger and deal with the stress of being an absentee landlord while in school so I don’t regret my decision too much. Either way the investment in that degree will be the best ROIC investment of my life so it all works out in the end.

  15. I’m a few years older than you Sam. I did not mention the massive infrastructure needed in the USA (can you say CAT), and baby boomers are moving south. That is why the IDEA of your LV property is a good one. I disagree with property in much of Midwest due to the trend of stagnant/declining populations. The 500 million population gap is a fact and could lead to much worse things than financial loss.

    1. I’m really focused on places like Dallas, San Antonio, Austin, Salt Lake City, Omaha. There will be another boom center that mimics Silicon Valley, Seattle, New York City, and my bet is that Center will actually be in the center of America: Texas.

      I hope you are right about Las Vegas!

      1. LA times article: They’re leaving California for Las Vegas to find the middle-class life that eluded them. Sleep well.

  16. I am full exposure. Demographics of USA are 4 million births per year plus immigration. America will do well because it has sustainable population growth. Demographics of Japan, Korea, and Europe will cease to exist as an entity in 30 years. This is not avoidable due to continuously low birthrates. China has a population gap of 500 million in your life time due to 1 child policy. This is why I am investing ever dollar now. There is no bubble. The bay area is becoming like Austria where you can’t buy a house unless the family dies out and they are. China will likely build factories in Africa due to population explosion, and manufacturing will return to the USA. There will also be migration out of EU to USA because the Europeans don’t have babies. USA is the place to be. There is no bubble. We haven’t seen anything yet and this doesn’t even cover what is happening internally. If I were lazy I would put my money in VFIAX and forget about it.

    1. Great to hear your conviction. How old are you?

      I agree about the Chinese population slowing down drastically in the next 10 years. There’s going to be a retirement fund in crisis.

      But the US population is also slowing down drastically. You’re at X growth, which means we need to go through productivity.

  17. “Having Maximum Exposure is investing everything you have in risk assets AND borrowing as much as possible to also invest in risk assets.”

    – Don’t borrow. Or at least don’t borrow “as much as possible” (this might vary on one’s interpretation).

    “Full Exposure is defined as investing all your cash flow and having all your assets tied up in risk assets plus a comfortable buffer.”

    – That’s the balanced sweet spot for us at the moment.

    I also reflect on the point you mentioned about buying at today’s low prices (whether property, equities, etc.). Making those types of decisions can be difficult to make. In the instance of your grandfather, who could have known the future value of the land at the time?

    On your other questions:

    1. What type of risk exposure do you currently have?

    – We’re currently ~25% real estate (via REIT Index & Fundrise), ~60% equities (primarily US domestic index and international index), ~10% bonds, and ~5% cash.

    How do you plan to adjust your exposure in the coming years?

    – We’ve transferred the bulk of our equity exposure into large-cap value stocks / funds. While receiving passive income / dividend growth is an objective, I’m concerned of a potential large down slide on the growth side. Some of the valuations just seem too high. We’ll look to increase potential small / mid cap growth in the near future. We also recently set all future retirement contributions to a bond fund for the time being (looking to build up short-term equivalents for buying opportunities elsewhere).

    1. I don’t know. I would like to think that if I was shopping for Land when my grandfather was, I would tell him this was a no-brainer in Waikiki. Just like how I think any property in San Francisco that has ocean views is a no-brainer and missed priced right now by 20% to 30%.


      Everybody has to take a viewpoint on something, and invest aggressively with a portion of their wealth they can’t afford to losePAF This is what happens in a bull market. Lots of opportunities arise. Just need to spend time looking.

      1. Fair enough and good point about investing aggressively in a particular opportunity.

        Your 2014 vs 2016 maps in the post you shared is very interesting. Just browsed some of the prices on a few sites, and yes, Realtor District 2, Sunset/Parkside, is getting a lot of hype.

  18. Sam-I have been following your blog for over 4 years now. Excellent post and really apt for the current scenario! This article should be mandatory for any college biz course as these are fundamentals that most people don’t understand about risk and return. Heck friends who are Ivy league MBA’s don’t understand this concept either.

    Great article and keep it coming. This one is important for anyone who wants to build a good net worth.

    1. Thanks for thoughts. The great thing about the Internet is that things gonna spread for free. I really want people to know what their risk exposure is, at any point in the cycle. Just knowing this will naturally make you pay more attention to your finances.

  19. Right now my wife and I are probably in the Reduced Exposure category. We never use margin to buy stocks and have a large cash balance for emergencies and a future down payment on a house. Once we have a mortgage we will probably be in the Synthetic Full Exposure category.

    I’m fine with not maxing out my investments since we will have cash available to deploy in case of a downturn. Also the saying that “You only have to get rich once” applies. If we continue our current path we will eventually become multimillionaires, so no reason to take on extra risk and headaches.

    1. That’s pretty cool that you can map out the inevitable track to multi millionaire status. Just takes time and not losing big on the way there. What are your main drivers to go to that financial level?

  20. Sam,

    Good information on risk and asset allocation.

    Is some of the remaining cash ya have parked to pay recapture and capital gains tax next year? I forget from the other articles how long you held the rental, every year you would have depreciated close to 20K using a 27.5 year residential schedule that’ll hit ya at 25% and long term capital gains at 20% on that 1.5+M appreciation.

    Sharing the tax consequences may be another great blog post!


  21. Yea, I don’t have anywhere near the firepower that Sam has so I am probably a bit more conservative. Every day the market is up on low volatility brings us a day closer to when the inverse will be true. I would like nothing more than the market to continue the upward trend forever. I am prepared for the day when my wish will not come true.

  22. We are moving away from full exposure downward. Hopefully, we’ll get to reduced exposure in about 18 months. It takes time to make real estate moves. At this point in life, I’m getting more conservative and reduced exposure would be the right spot for us while the stock market is flying high.
    We’ll go back to full exposure once we see some great bargains.

    You did a great job maximizing your resources. That’s why I’m a big fan.

    1. Thanks Joe. Next year might just be the perfect time for you to sell your rental and simplify life. The mass affluent price point here in San Francisco is slowing. Prices have been flatlining or declining in New York City for the past couple years already. I expect cities like Seattle and Portland to be next in the coming years.

      Or, maybe Amazon gets to $2000 a share and takes over Portland as well!

  23. I currently have 40% in risk free assets. I am not counting the equity in home. I highly recommend that everyone write a Personal Investment Policy Statement. These can be the “rules of the road” on how you invest. For me, given where the market is at this time, it has me at a max protection. There are rules I have written to allow me to get back in. I tweet it once a year and have added some tactical elements. This allowed me to invest in an emerging markets ETF earlier in the year with a minor position. Anyway, this all becomes much easier when you live by the own rules you have constructed.

    1. Good idea. Everybody has to make their own goals with what to do with their money. Making money for money’s sake gets pointless if it is never going to be used.

      How old are you? What I struggle with is missing out. But, I’m lucky to have strong cash flow right now. As soon as my cash flow dries up I will adjust accordingly.

  24. Sam, maybe you can design a quiz that classifies your readers into the categories you talk about? Would be interesting to see the splits of your readership, since that’s what everyone is really doing here in the comments section. I can even see you having a meter like that website that tracked mortgage company blow ups from 2007-2012 (the implod-o-meter i think). If you gave the quiz multiple times a year it would be really interesting to see the shifts over time in relation to the market. I bet your readership will successfully prepare for a bear market better than most, both with de-risking into a bear market and then leveraging up at the appropriate times for maximum exposure.

    Good article, I’m heavy exposure in rental properties in a coastal city, which reflects max exposure. That’s made me realize that i have a rational disconnect since I have a bearish outlook on most asset classes –I should look for ways to move from maximum exposure to full exposure. Do you consider cash flowing rental properties as a true risk asset? When the valuation takes a hit, you still have cash flow, and a nice hedge against inflation. Primary residence, sure, but rental property isnt quite the same, no?

    1. Everything that I can go down in value is a risk asset. Rent can go away Because tenants can lose their jobs. Although, rent was very sticky during the downturn in 2008-2010 in San Francisco. I never had a vacancy, and I never lowered the rent, just kept it the same.

      If your cash flow rental properties aren’t causing you stress, I would just hold on forever.

  25. Damn Millennial

    Hey Sam,

    Where does your comfortable buffer come from? Is that based on monthly expenses or just a personal number? I am guessing personal as it is a nice round one @ 100k.

    I am in full exposure and plan to be in that range for life. The bull market has helped me to build up a decent stock portfolio for my age and I am confident in the plan. I am putting about 60% of my pay into diversified stocks and 40% into my modest mortgage. My game plan is to have a paid off home as it is an expense I can control vs. leveraging my property to invest in the markets and hope everything keeps rising. I plan on working until I am in a home I love paid off and have enough passive income to support a healthy lifestyle. At that point I will have the choice to step away from work forever….or continue to work and splurge on things I don’t need.

    1. The funny thing is that I hope you don’t want to feel you need full exposure for life. Once you hit your target net worth cool that will allow you not to have to work, there really is no need to be at full exposure unless you have this intense need to run up the score.

      The hundred thousand dollars is based on an expense ratio and based on how much I like to invest in opportunities. The reality is, doesn’t really matter so much because I can sell stocks and bonds quickly to get liquidity within three days.

      1. Damn Millennial

        Being 27 today I can only imagine I will be a completely different person at 57 and might adjust over time. Today however I don’t see the point in not being in the full exposure category until I am living the life of my dreams.

        Very true there are other ways to get the liquidity.

        P.S. how are you enjoying your range rover, haven’t heard any updates?

  26. “My grandfather could have bought beach front land in Waikiki during the 40s for nothing, but he didn’t want to be next to a butcher. Darn it.”
    Awww haha so relatable. How are schools there for Samurai Jr if you guys ever move to Hawaii?

    My husband and I are between max and full exposure. I know people say take advantage when you’re young but you would need a strong stomach for maximum exposure. I can’t fathom a downturn with 700k borrowed, it doesn’t sound fun. If we do have children someday, I would reduce our family to less than 500k in borrowed money.

    1. Children definitely will make you want to be more conservative. Since no longer is only you and your partner’s financial life at risk.

      The good thing about kids is that it will also motivate you to make more, save more and be more financially savvy overall.

  27. The detectorist

    Even with enough debt in my accounts I still feel that I will be ok with more debt and more exposure. Not sure if this is the right approach, but I’m looking usually at the downside in case the market will fall.

  28. I have the almost 90% in small cap/high-risk assets. I still have a lot of years until retirement. I do want to put in more cash in my after-tax account into investments of greater risk because as you mentioned the party could continue for a couple more years. I’m considering putting more into REITs (maybe my IRA for next year) since I don’t want the hassle of owning and renting out a rental property.

  29. Sam, interesting post. We’re 6 months from FIRE, so we’ve been intentionally moving to “Reduced Exposure” to minimize Sequence of Return Risk. We’re 60% Equity / 30% Bonds / 10% Alt. Like you, I have a “Synthetic Mortgage” (we have the cash to pay it off, but are keeping it for arbitrage), and we’ve got 2 years of living expenses in cash.

    It’s a question of when, not if, the bear rears up and starts swinging his claws around. We’ve got enough dry powder to let him settle back down, but we’re still exposed enough to maintain adequate diversification.

    1. Sounds like a good plan! Having enough cash to pay off debt feels great. Although, crap hits the fan, paying off debt will probably not be a top priority since liquidity becomes more valuable in a bear market. But since you will need a job in a couple years, you can do whatever you want!

  30. My current net worth make-up is: 30% Real Estate (Paid off House) / 16% (Market Exposure) / 50% (Cash) / 4% (Alternatives Exposure). I would consider that heavily reduced exposure. My cash flow has been strong the past few years and I’ve been reluctant to go heavy into equities at these levels. I’m comfortable taking my time to reduce my cash exposure over the next 5 years, since my cash flow should remain strong. My target is to retire at 45, and I should have a net worth about twice where I am now by then, even with a reduced exposure.

  31. Speaking on regrets, I rode the stock market wave in 2008/2009 to some great returns, but got nervous a few years later and reduced my stock exposure significantly. Unfortunately this means I missed out on some of the growth since, but it’s nice to know I’m ready for the next downturn.

    Of course, being a homeowner in Silicon Valley, the real estate market is outrageous, but at least I’m on the beneficial end of that meteoric rise.

    The only certainty is cycles, so it’s best to prepare for the next bust during the current boom.

    1. Being long Silicon Valley property has been a great lottery ticket.

      The problem with cycles is that eventually we will either be too old to work or be dead. So we really only have so many cycles in our lifetime is to take advantage.

  32. We are 30 and currently have a roughly 90/10 split on stocks vs bonds. About 25% of our net worth is in the home, 70% investments, 5% cash. I’m considering moving more money into something stable so we can buy a rental property should the market turn. I just hate to miss out on all these sweet returns.

  33. FullTimeFinance

    We’re currently deriding as we pay off our mortgage. Beyond that we’re 20 percent in bonds. It’s all about your personal risk tolerance.

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