Neilen’s Occasional Perch

This post is something quite different from my normal fare, dealing with financial decisions rather than gardening or food. May make for interesting reading though. In short, I’d like to be able to retire when I’m 40. Well, perhaps not properly retire, but at least be able to, say, wander the earth for 5 years without eating my capital. I would like to do this in spite of having gotten a late start (long academic careers do that to you), being somewhat lazy and also being quite risk averse. But, often times, taking no apparent risks is itself not merely risky but in fact downright reckless. By taking no chances now, I’m pretty much guaranteeing that I won’t reach my goal.

Minor epiphany

I work at a pretty amazing place where our main (OK, only) product is Antenna Magus. Unless you design or integrate antennas for a living you’ll have little use for it, but take it from me, it is the shizzle. It’s shiny and new, innovative and unique in the market place. People love, want and are buying it; the potential upside is enormous. But it is new and we are in a very conservative market. And unless you’ve been stuck in cave, you might have noticed that the global economy is in the crapper. That, and the much reduced liquidity inherent in investing in a private (as opposed to publicly traded) company, makes investing in it fairly risky.

Recently I was given an opportunity to invest in Magus, but my risk-averse nature and the fact that it would have to be a leveraged transaction (i.e. I’d have to borrow money) led me to reject the offer out of hand. It did however awaken me to the fact that I need to be willing to take larger risks to reach my goal of semi-retirement at 40! To take these risks (such as buying Magus shares) I need at least moderately steely balls. Unfortunately mine are currently somewhere between paper mache and a soft wood. Let’s say cork.

Time to HTFU

Dr Chopper has some advice for me, so I need to find a way to move from my comfort zone into the steely-ball zone that I need to be in. I need to find some intermediate step up the ladder, perhaps something requiring balls of, let’s say, pine wood at least.

Why take risks?

Why should one take risks? Simply because of risk premium. In short, when there is a higher risk of failure there is usually also a higher expected return, even when taking into account the odds of failure. Many people get into trouble by taking stupid risks, so how does one decide if a risk is worthwhile?

Risks can be bad for two reasons. Overestimating the risk premium is the most fundamental mistake; just because a risk is being taken doesn’t guarantee a premium. Gambling on slot machines is a good example; play the game enough times and you will end up losing to the house. Corollary: if you play slots, do remember to quit when you’re ahead :)

The second problem is the absolute size of the risk. Risk premium is an average effect; even with a good premium you might lose this time around. Losing a night’s drinking money is no biggy, but losing 100 year’s worth of salary through some astronomically leveraged transaction is likely to break your back; if then you can’t afford to play again you have lost. Corollary: If possible, diversify your bets and don’t take risks with money you can’t afford to lose.

My parameters

Before taking a risk, you need to know two things: Why are you taking the risk, and how much are you willing to lose. For my semi-retirement at 40 I need, assuming that I can get a 10% return on my investments at that stage, about 10 times my expected yearly expenses invested. That is in 9 years time, so conservative investments will clearly be inadequate.

As for how much; I have no onerous financial commitments, neither do I have dependants to support. Given that,uhm, detailed analysis I’ve decided that I should be willing and able to lose up to a year’s salary. However I’m not currently steely-balled enough to risk that much, nor really able to borrow that much, so I’ll have to take smaller steps along the way.

What to do

Now I have to find investment opportunities that fit into this plan. I have some ideas, but I’ll spare those for later. I’ll just take this opportunity to brighten my friend Simon’s day by saying that it almost certainly won’t be direct property investments. As recently as 3 years ago that might have been a good idea, but I’m really not expecting above average growth in the property market any time soon.