More Risk, More Reward?

Perhaps inspired by home makeover reality shows, Trading Places, Extreme Home Makeover, etc., newspapers and magazines often run portfolio makeover articles. They typically feature a real family, tell us about their finances, their goals and their struggles. Then the newspaper or magazine brings in a financial planner who offers advice for them. I think people like them because it brings personal finance to the real world. When I was traveling for business last week, I read this article in USA Today (Jan. 8, 2007, page 6B):

Can they retire young and rich?

The article told a story about a young couple, Luke and Hannah Wickham, 30 and 28, saving aggressively toward a goal of retiring between 50 and 55 with $10 million. This couple did very well. They already accumulated $258,000 in stocks, mutual funds, bank account and private equity investments, their own home and 3 rental properties in Orlando, FL worth $529,000 net after mortgage obligation. That adds up to $787k in net worth. I don’t know how many people in their late 20s can top that. Congratulations, Luke and Hannah!

How did they do it? They saved more than 20% of their income and invested aggressively in stocks, mutual funds and real estate. They plan to save $30,000 from their $137,000 income in 2007. That’s a 22% savings rate. People wanting to learn from them should really take a lesson here — you can’t accumulate a high net worth without a disciplined habit for saving. Otherwise even luck can’t help you.

What suggestions did the financial planner give them? Here’s what the planner had to say:

Planner: They’re off to a good start but need to be careful

The planner basically said luck was on their side in the last six years since they started saving and investing and it’s time to lighten up and take less risk. The planner equated the real estate gains in Orlando to a “once-in-50-to-60-year occurrence.”

The kicker is really at the end of the story.

The Wickhams say they aren’t surprised by Fitzgerald’s suggestions, and they agree with many of them. They plan to adjust the asset mix in their portfolio and open a money market account.

But despite the planner’s recommendations to reduce investment risk, the Wickhams don’t plan to stay away from real estate or individual stocks.

“We’re not going to go that route,” Luke Wickham says. “More risk, more reward, in my opinion.”

Ding! Really? While one has to assume some risk to realize the reward, more risk doesn’t necessarily mean more reward because some risks are not compensated. Risks that can be diversified away are called non-systemic risks. Non-systemic risks are not rewarded. When you have been lucky, you can’t count on being lucky all the time. Moreover, with the assets the Wickhams already accumulated (with the help of being in the right real estate market at the right time), it’s not necessary to take on more risks. If you have good chance of hitting $10 million, shooting for $100 million and ending up with $1 million is just not worth it. The planner gave the Wickhams very good advice. I hope they don’t brush them aside.

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  1. samerwriter says

    I read that article, and it really bugged me.

    I agree that the couple is off to a great start. But calculating the net worth of someone with significant real estate investments at the peak of the real estate bubble is like calculating the net worth of a silicon valley stock option millionaire in 1999, and claiming that “planning” had something to do with it.

    We all rely on luck to some extent, but if they’re going to profile people who lack diversification in their investments and are doing well, they should also mention that many people who lack diversification do very poorly. Like people who put all their money in pork belly futures or precious metals. Or put all their money in real estate a couple years ago, rather than 10 years ago.

    And then they should point out that there, but for the grace of a higher power, go Luke and Hannah Wickham.

  2. Harry Sit says

    Agreed. Just like a silicon valley stock option millionaire in 1999, I’m afraid this couple will push their luck too far. Unfortunately real estate is more difficult to unload than stock options, but they probably think it’s OK to play with “house money” (pun intended).

  3. Anonymous says

    More important is the attitude of less now, more later. And I believe this is key to how and why this couple will succeed. My husband and I married at 24 & 25, and had the same attitude. We worked 12 plus hour days often 7 days a week for years. We had our ups and downs, almost lost it all twice. We’ve hit the goal that this young couple has set in our mid 40’s and hope to retire in the next 2 years. While our business ventures are slightly different, the attitude was the same. We went several years with one car and packed lunches when there was money in the bank. Keep your eye focused on your goals and keep going!

  4. Seamus says

    I’d love to see their portfolio today! Just looking at a few of the stocks and funds listed and they all seem to be very close to their 2005/6 value. Not to mention how their real estate portfolio would be looking.

  5. Patrick says

    This is a financial catastrophy of late likely if they did not change their approach fast after the artical – I am going to gues sthey had not since 50k cash was sitting in a low interest account because they “did not have time”. That house is surely under water and was wa beyond reasonable expectations even for a 134, k gross income between the two. With the equity vanished in their home and aparently other realestate investments the loses there surely exceed anything they can hope to recover for years. Not as many people taking tennis lessons of late too I would bet. Also there is no planning on children in lofty saveings expectations not sure if they intend to have children. Nearly all of these singular stocks not only peaked shortly after the aritical but were some of the biggest losers and definitely not diversified amungst any other sectors to start and heavily in what turned out to be the worst. I would bet the “additional 30k” that they miraculously were going to pull from thin air and invest never happened. If 50k is only 8 months expenses then they were a bit beyond anything reasonable for their 134 gross income + 20% saveings.

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