Frugal Living & Managing Risk, IV

In response to the e-mails that I received with regard to my "Frugal Living & Managing Risk" series:

1. Aren't you a bit too conservative in your strategy? How would you ensure that you do not outlive your retirement savings?
   This is a good question. What most people forget is that stocks are inherently risky investments. There is no such thing as risk-free stocks. While stocks offer the potential of good returns, I would also argue that stocks carry significant risks that people ignore at their own peril. Those who focus on the fact that the long term average return of stocks beat other investments often forget that historical figures indicative of future performance. When investments dropped 30%-40% in 2008, it is really painful and will take a long time to recover. The stock market cannot guarantee an annual 10%-20% return to make up for a 30%-40% drop in 2008. Hence, I stand by my decision to invest in stable-value funds, a decision I made in 2006.


2. Would you ever invest in stocks or mutual/index funds?
   I don't rule out investing in stocks, index funds or mutual funds. My strategy comprises keeping my 401K and emergency fund in conservative investments (stable value funds for my 401K and high yield savings/CDs for emergency fund). Once I fully fund my 401K (to its annual tax-free limit) and emergency funds (to 1 year's worth of expenses), then I would invest in stocks, index funds, mutual funds, etc.., which I would consider as my "extra investments." If I lose any money in my "extra investments," the losses would be limited to the "extra" money that I could afford to lose. Retirement and emergency funds are money that I cannot afford to lose. In other words, I have deliberately adopted a conservative investment strategy that requires me to save more, rather than to take higher risks. The 2008 financial crash is a reminder to us that an aggressive investment strategy is no antidote to inadequate savings.
   

Previous postings in this series:
Frugal Living & Managing Risk, I
Frugal Living & Managing Risk, II
Frugal Living & Managing Risk, III