Updated: Apr 16
Your choice is:
-Job A: $600,000 Income, but you're 13 times more likely to be MURDERED; or
-Job B: $300,000 Income, but you have to move to the desert for relative safety
This is the decision some of the most lucrative sex works in America are faced with when choosing to find their own customers (Job A) or work at an organized legal brothel (Job B).
Ph.D. Economist and Retirement Specialist, Allison Schrager, wrote about her adventures of studying real risk management tactics implemented by the most extreme professionals such as sex workers, poker players, Hollywood film financing, big wave surfers and more!
These brothel workers may not realize it, but the decision to trade earning for reducing risk is known in the "finance world" as a hedge.
Schrager obviously used a slightly more exotic example for her book title than the lessons she teaches normal-people to implement, such as the hedging strategy used when purchasing life insurance.
Schrager states, "we tend to think of risk in a binary way: either you take a risk or you don't; either you have certainty or the future is totally random and unpredictable." When in reality, there are no guarantees in life and we make dozens of uncalculated decisions every day.
She goes on to explain that humans have cultivated our modern era by developing language and the ability to read and write; and predicts that the next evolution of cognitive thinking will come in the form of risk analysis to benefit our everyday lives.
This type of everyday risk management is already taking place. Think about NETFLIX predicting movies that you'll like, Google maps providing optimal routes and real time ETAs, dating sites based on compatibility, Amazon predictive marketing, etc.
We are just starting to scratch the surface, but imagine what your life would look like if every decision you made had the highest probability of success. No more aimlessly walking around the mall looking for Christmas gifts! Whoa!
"The biggest mistake people make when they take a risk is not having a well-defined goal."-Schrager
Another tactic she warns to help reduce risk is by understanding that humans have an aversion to loss and our perception of risk is often not based on objective probabilities. E.g. airplane crashes, we both know the statistics say it's not gunna happen, but we still freak out over a little turbulence.
After reading about Schrager's study of the wildest and riskiest professions, two majors take-aways were to:
1) Define your goals; and
2) Understand the true perception of risk
I was so pumped to read this because I LITERALLY do this as an advisor (yes, this was the exact moment I knew I was going to write an article about this book)!
I realize that prostitution and successful retirements aren't exactly the same, but there are still risks involved.
(This is NOT investment advice):
A 65 year old lady in 2019 is expect to live another 21.5 years.
Let's assume she has $100,000 and needs to withdraw $5,000 each year for groceries. And lets assume inflation remains at the previous 20 year average of 2.2%, meaning that by year 21 (age 86) she will need to be withdrawing $7,897 to buy the same groceries.
1. Define Goal: Protect money so you don't run out
2. Perception of Risk: Avoid market "risk" and use guaranteed investments (rates are around 2%)
Using this "safe" investment strategy the client would experience zero market volatility, but that's NOT the REAL RISK because this strategy would in fact give the client a 0% chance of success as they run out of money in 19.5 years - a full two years short of their goal!
1. Define Goal: Grow money so you don't run out
2. Perception of Risk: Anything below an annualized average return of 3% is failure
The goal of this article isn't to give investment advice in this situation, but bring to light to the REAL RISK here.
But just for fun, lets assume the client invested in a moderate 60% stock & 40% bond portfolio (mainly because I have some good data on this type of portfolio).
Over the 39 year period from 1980 to 2018 this model has average 10.2% annual returns. If the returns held true, our "example lady" would still have $87,000 after 21.5 years of withdrawing an inflation adjust $5,000 per year - compare that to running out of money 2 years early!
"But the market is risky, Colin!"
I completely agree that markets are risky in the short-term and using this allocation you would've had to stomach a 20% decline in 2008.
I'm certainly NOT suggesting that I would recommend this portfolio in this situation AND I'll acknowledge the very serious risk of sequencing (what if 2008 happens on day one of retirement), buuuuuut lets look at the facts:
Over the 93 year period from 1926 to 2018, a 60/40 model has had an annual positive return 80% of the time and it has NEVER had a 10 year period of negative returns.
My Sincere Advice
This is NOT investment advice.
Identify your goals and what success means to you.
Take the time to understand the real risk.
Sometimes safety isn't actually safe!