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. 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 ad 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.

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 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. Take a look at my two favorite real estate crowdfunding platforms that are free to sign up and explore:

Fundrise: A way for accredited and non-accredited investors to diversify into real estate through private eFunds. Fundrise has been around since 2012 and has consistently generated steady returns, no matter what the stock market is doing.

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.

I've personally invested $810,000 in real estate crowdfunding across 18 projects 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. 

Recommendation To Build Wealth

Sign up for Empower (previously Personal Capital), the web's #1 free wealth management tool to get a better handle on your finances. In addition to better money oversight, run your investments through their award-winning Investment Checkup tool to see exactly how much you are paying in fees. I was paying $1,700 a year in fees I had no idea I was paying.

After you link all your accounts, use their Retirement Planning calculator that pulls your real data to give you as pure an estimation of your financial future as possible using Monte Carlo simulation algorithms. Definitely run your numbers to see how you're doing.

I've been using Empower Personal Capital since 2012 and have seen my net worth skyrocket during this time thanks to better money management.

Retirement Planning Calculator

Check out my Top Financial Products Page and subscribe to my free newsletter to help you achieve financial freedom sooner, rather than later. The Main Types Of Investment Risk Exposure To Be Aware Of is a FS original post.

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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?


    1. Joe,
      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…

  2. 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. 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. 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. 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. 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. 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. 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.

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