In a discussion about risk on the Bogleheads forum, member John Norstad brought up an intriguing question. Let’s say you won $1 million (net after taxes) in the lottery tomorrow. This money will get added to your existing investment portfolio, and may or may not be enough to allow you to fully “retire” as you would like to. As a result, how would you change your investment style?
Make it more aggressive. Sample reasoning: Now that I have a head start and a cushion, why not gamble a little and see what happens? I should buy more stocks, and perhaps I can retire even earlier or with a bigger nest egg. This is given the term Decreasing Relative Risk Aversion (DRRA).
Make it more conservative. Sample reasoning: I’ve just gotten much closer to my goal, and I don’t want to mess it up. I can now invest more in safer things like bonds and be more confident in reaching my goal eventually. Known as Increasing Relative Risk Aversion (IRRA).
Keep it the same. Sample reasoning: I have a set allocation set up, and I see no reason to change it. Anything I don’t spend, I will leave to my heirs. Known as Constant Relative Risk Aversion (CRRA).
Loading ...
The Best Credit Card Bonus Offers – November 2024
Big List of Free Stocks from Brokerage Apps
Best Interest Rates on Cash - November 2024
Free Credit Scores x 3 + Free Credit Monitoring
Best No Fee 0% APR Balance Transfer Offers
Little-Known Cellular Data Plans That Can Save Big Money
How To Haggle Your Cable or Direct TV Bill
Big List of Free Consumer Data Reports (Credit, Rent, Work)
That’s very interesting that people would be more conservative.
So you are more likely to risk the money you’ve worked extremely hard for, but you’d be very risk adverse if someone gave you a boat load of cash?
Kind of counter-intuitive.
I think the most important factor is your age. My argument has been always if you have enough to retire, IMHO you should be taking more risks with that extra net work.
Investment decisions have nothing to do with how the money was obtained. “Say you won a lottery” is just a way to say “what if your net worth increased tomorrow by $1 million”. If my net worth increased by $1 million I would have much less need to risk funds in the market. I would invest it conservatively and sleep well at night knowing that every “really bad day” for the stock market is going to have very little effect on me.
I thought about this for a while… When it comes right down to it, I just got several years (maybe a lot of years) closer to my (now younger) retirement age. That means it’s necessarily time to get more conservative.
I disagree Warren. Buying a lottery ticket means it was “play” money to begin with so why should it not still be “play” money after you win?
Perhaps this is a bad example though, since in this “lottery” case, keeping a constant strategy means keeping a very risky strategy (the lottery ticket you bought was a very high risk investment).
I agree with Warren. It doesn’t matter how the funds were obtained. What matters is today going forward. If I won the lottery, I might consider retiring (which isn’t in the cards right now). That choice changes my outlook, and a more conservative investment portfolio might certainly be appropriate.
It is illogical to treat income differently based on source. It is all part of the same pool of resources at your disposal and what matters is what you intend to do with it.
Poker players have to learn this lesson (or they’ll be losers). It doesn’t matter what has happened in previous hands, whether you’ve won or lost. You have to play the hand you have, at the table as it currently stands (i.e. with various amounts of money in the piles of the other players).
I would definitely get more conservative.
In fact, if I had enought today that I could reach my “number” years from now when I plan to retire by simply putting it all into government bonds I would do so and stop worrying about it. Increasing equity exposure means you can earn a higher expected return, i.e. save less and consume more and still expect to reach your “number” at retirement. However, it also increases the probability that you will fall short or exceed the required amount by significant margins. To me this is the same decision as taking the portfolio risk down as you accumulate a larger portfolio and get closer to retirement.
As you age and accumulate wealth more of your ultimate retirement portfolio is driven by past savings and future returns than future savings and past returns.
Winning the lottery would be mean I’ve met, possibly exceeded, my long term investment goals and objectives in a much shorter time frame. That also means I have to make the pot last for a longer period. It would take some “figurin’ and cognitatin'” to determine, but maintaining some aggressive position would be necessary, although I think possibly to a lesser extent than I do now.
On another matter, and forgive me for going off topic somewhat, but I often see the scenario playing out like this for me. I win the lottery. The next day I come moseying into work around 10:30, unshaven, and wearing shorts and flip flops. I check my e-mail, do a little web surfing, and then leave for an early lunch. Back in around 2:30 or so, check e-mail again, and then go home early. Next day, repeat same. Funny thing is I could do this for several days at my workplace before anyone would think to approach me to see what the deal is!
Personally, I am very risk adverse. But the reality is I can never afford to retire if I don’t invest heavily in the stock market (right now). So, if I no longer needed to take that risk to make my goal, I wouldn’t.
It’s the same if I inherited money, or my income increased (both very likely). I expect to invest more conservatively eventually, anyway. Until then… (I am in a temporary space where working less and making less money is more important to me – small kids – so more risk needed to offset current circumstances).
Being risk adverse, I have no desire to gamble in the hopes of getting more money than I *need.*
P.S. I wouldn’t stop working if I won the lottery. So, I understand if one wanted to be more aggresive to make a lottery windfall last longer for immediate retirement. I’d personally rather work longer and take the more conservative approach, myself. I think taking on less risk is more important to me than retiring. Retiring is low on my list of priorities. So, is another big difference in my answer. I want to have the financial security to retire some day, but I am very happy working until then.
Thanks for all the insights, this question is definitely an interesting one. By the way, there is no “right” answer. Everyone has their own risk preferences, today and even after winning the lottery.
I don’t like taking risks. That’s why I’m invested aggressively in stocks…I think relying on bonds and other would be too risky… what if I haven’t made enough money before I retire to keep up with inflation. That seems far more likely to me than stocks not outperforming bonds over the next 50 years I’ll probably be in the market.
If I have an extra million bucks, then I can afford to worry about a new risk…what if the market completely tanks…like loses 80% of value. Not just a depression…literally something we can’t recover from. I’d want to protect myself against that as best as possible.
It’s diminishing returns. Once you get a certain amount of money, it’s not that important to get more. In my opinion those that would be taking more risks with the million, probably should be investing more aggressively right now… assuming “risks” doesn’t mean crazy risks.
Having received an early-retirement offer in 2006, I immediately changed all of my investments to log-term conservative CDs (between 5% and 6%), so that when withdrawing income from my IRAs under 72t provisons, I could count on withdrawing interest only – and never any principal (worked very nicely during the 2008 downturn).
Any new money from lottery winnings or an inheritence would be invested conservatively as well, as an infaltion cushion and perhaps a raise in our standard of living.
Those most likely to win the lottery are the people who play it frequently. This means lottery winners are usually not conservative investors almost by definition. I would like to see an actual study of how lottery winners really do financially in the years after they win. Anecdotes abound of how miserably they fare, but these are undoubtedly just the worst-case examples.
Of course, I realize that this is not the point of this survey or discussion. Just wondering.
Interesting prospect to daydream about. I think overall I would keep my allocation the same, maybe take a few flyers but I think it would give me the freedom to invest in my own business. Take $250K and start something fun. Pay off the mortgage or buy a second property and invest the rest. Something fun to think about but I am fully aware that I might as well get struck by lightning as winning a lottery, hopefully the later would happen if one of them would happen.
I saw a real world example of this back in 2000 when many of many coworkers (in their 20s) had a stock option windfall in the $100000 range. Plenty of them immediately invested it in tech stocks instead of paying off debt or preserving a generous emergency fund. Didn’t turn out so well for many.
Bingo Donald. I’ll bet the house that all of the conservative investors commenting here don’t play the lottery. Those who play the lottery are already high risk investors.
its simple, if you’ve hit your number are financially independent, you want to preserve your capital. not risk it. duuuuuuuuuh!
Donald hit on an important point. This example is hypothetical there are many studies and reports that show how a lot of lottery winners (due to their aggressive habits and imprudent financial planning) actually declare bankruptcy soon afterwards:
http://www.smartmoney.com/invest/stocks/why-lottery-winners-go-bankrupt-1301002181742/
http://www.totalbankruptcy.com/news/articles/miscellaneous/lottery.aspx
http://finance.yahoo.com/retirement/article/110553/jackpot-winners-just-as-likely-to-go-bust
http://www.uky.edu/~swhank2/research/lottery_bankruptcy.pdf
Regardless of age, if I was close to my retirement goal, and could safely withdraw my monthly needs, then I would most certainly treat it more conservatively than if I had been given 100k and still had a long way to go.