By David Ning
Let's say someone made you an offer that goes something like this: He will flip a coin and if it comes out heads, you lose $5, but if it lands on tails, you win $10. You further find out that there are absolutely no gimmicks to this game, meaning that there is an exactly 50/50 chance of the coin landing on either side. You are also allowed to play an unlimited amount of times. It's easy to see here that as long as you can afford a string of losses in a row, you should keep playing because you are expected to become rich by continually making this calculated bet.
You're not likely to receive an offer like this because no one would knowingly lose money. But plenty of similar opportunities exist that will help you gain a better chance to retire well. Now, the odds are not going to be so clearly stacked in your favor, but when the expected outcome is positive in the long run, then the best course of action is to keep making the bet as long as you can afford the losses. Interested? Here are some examples of investments that are typically worth the risk:
Investing the whole lump sum is likely better than dollar-cost averaging into the market. While there are many psychological reasons to dollar-cost average into the market whenever you get a big sum to invest, investing the whole lump sum as soon as you receive it turns out to be better most of the time due to the general upward trend of equity and bond markets. There are plenty of excuses to keep a lump sum out of the market including the facts that the market is at an all-time high now, valuations seem high, the Fed could wind down its push to accelerate the economy and it's very possible that the market will tank the second you submit a buy order. However, people also had plenty of reasons not to buy into the market over the past five years, but I doubt any stock market investors have come to regret their decision or the growth their money has experienced.
Put money in Roth IRAs as early as possible in the year. Not everybody has a chunk of idle cash to deploy on Jan. 1, but everyone should try to max out a Roth account as soon as they can. %VIRTUAL-WSSCourseInline-734%The sooner you add money into these after-tax accounts, the less taxes you will ultimately pay. I know many people try to wait until a dip in the markets before they put a chunk in their tax-advantaged accounts, but remember that markets tend to go up. You'll get a better expected outcome if you invest sooner, and the more often you do it, the higher the chance that the odds will be in your favor. This advice also holds for other types of tax-advantaged accounts including 529s, HSAs and even 401(k)s. However, when contributing to a company plan, make sure you won't miss out on part of your 401(k) match if you contribute early instead of gradually contributing from every paycheck of the year.
Perhaps it's prudent to invest more aggressively when market sentiment is extremely bearish. During the depths of a bear market, everyone will be panicking for different reasons and sell, but it's wise to delay selling until valuations recover. For those who have a stomach of steel, are properly diversified globally and who can afford to lose their money in the extremely unlikely event that equity markets go to zero, there's even a case to be made to shift some of your bonds to stocks because the long-term expected return of stocks at the low points is so high. Historically, global equity markets as a whole have always bounced back, but you will need to proceed with caution on this one because there will never be a guarantee that equities will always return to similar historic valuations.
Skip insurance on everything that you can afford to self-insure. I look at insurance with skepticism, because if people who buy insurance win out, then who would be crazy enough to offer insurance? In general, insurance has a negative expected outcome. But for accidents that we truly can't afford to pay for, then it's worth every penny. Life insurance, for most people, falls into this category. So does insuring against accidents on your health, car and house. As for other types of insurance, you really have to look at your own financial situation. Can you afford to take the loss if the unfortunate event were to occur? If so, self-insure. Otherwise, buy the insurance and be happy if you never have to collect.
Keep the mortgage, but only if you can stay the course and keep investing. It's usually a good idea to pay off your mortgage early, because too many people end up spending more when they see an inflated investment account due to not using the funds to pay off their mortgage. Plus, the psychological freedom of being completely debt free is hard to beat. Still, keeping a mortgage and using the money instead to invest has a positive expected outcome. The key is to make sure you are consistently investing the extra money in the market whether the market is at a high or a low, and that you don't end up spending more. For those special few with the discipline to pull this off, this maneuver could be worth the trouble.
It doesn't always make sense to take on more risk in order to try for a higher expected return, but those who can stomach the losses have many opportunities they could take advantage of. When you make bets that have a positive expected outcome you are likely to come out financially further ahead as long as you can afford a long string of bad outcomes.
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By David Ning