How much risk is too much?
Let me start by telling you about my strategy and why it's probably not the best one for you. I invest about 70% of my income, and almost all of it into a single global index fund.
But I have a few things that make this make sense:
- My house is paid for already
- I don't have car payments
- I've learned to be frugal and tone down my lifestyle
- I have a decently high income
- I have lost a lot of time baying off student loans and the like
- I have paid off all of my debts and have an emergency fund
So I am making more than most people in Japan, but in a sense I started investing late. Since I don't have the advantage of time, I am trying to make up for that by contributing a lot more. Had I started 10 years earlier, I would only need to contribute roughly half as much.
Friends have asked me about my investment strategy and said "Oh that is smart.. I'll do that too!" Imitation is the highest form of flattery and all that - but some of these people have credit card debt and no emergency fund. Some fave dependents they need to take care of. Some are younger than me, and most have less earning power.
I don't just think that trying to pick stocks, gamble with FX or options, or "invest" in cryptocurrency are too risky for almost everyone - I believe that investing all of your cash flow into an index fund is still too risky.
First, it doesn't make sense to invest in a an index fund with an expected wobbly ~7% return (on which you will have to pay taxes in many cases) when you have credit card debt at 12%. If you realize this (as I did) then you need to become ruthless about paying down your consumer debt. Anything over 4% needs to go, for sore - and as quickly as humanly possible Let me say it plainly: You can never invest if you owe consumer debt. That cold harsh reality hit me a few years ago, and I just stopped. No more new phones, no more new computers, no more fancy clothes, no more cafe lattes at Tully's coffee, and especially no more drinking and karaoke with co-workers. No more eating out. I just went scorched earth for 2 years and paid everything off. Student loans, credit cards - everything. Neew new clothes? Muji or Uniqlo. Need to eat? Cook it. Paying off your debt is something that just needs to be done now if you are interested in financial freedom. Living below your means isn't as fun, to be sure, but not only will you need to do that to pay off debt - you will need to do it in order to invest too - so it's good practice.
Secondly, if you are most people, you need an emergency fund. I added this later, because I know I would be tempted to spend it if there was cash laying around - but you need a way to cover unexpected short term expenses, and a credit card usually isn't the best option.
Finally, even once you have paid off your debt and built up an emergency fund, you also need peace of mind. It's easy to say "I will be fine if my portfolio drops 30%", but most people react differently when it actually happens. I know I don't, since it's happened multiple times - but most people do. There is a simple way to tame the volatility of the stock market - just keep some portion of your money in cash. You don't need to get fancy with precious metals, bonds, or foreign currencies - just keep some percentage as cash. For example, if half of your portfolio is in cash, then when the market suddenly drops by 30%, your holdings only drop by 15%. The same, of course, is true on the upside - but you need to be able to hold your position in order to make the earnings you deserve in the long term. If you say to yourself "I want that juicy 7% return, so I am going all in on stocks!", but then you can't sleep or start considering selling the first time the market drops 30% - well then were never going to earn that fabled 7% anyway.
So, I implore you to think deeply about how much you are really going to mind when the market drops - because it certainly will. Calibrate your investment ratio based on that. maybe 20% cash is enough for you, maybe you need 60%. There's no shame in that. None at all. You will be giving up some long term returns in theory - but you will be more likely to stay the course and at least get the projected returns you deserve. Holding cash isn't actually more conservative in this case, it's more bold in a way. You are essentially saying "If I have this much in cash, then I can promise myself not to sell at the bottom of the market and lose money" - and that is the most important thing of all.
You can always adjust your ratio as time goes on and you find out what lets you sleep at night. If the market drops 50% and it doesn't bother you that much, then perhaps you can reduce your cash position. It will be an opportune time to buy stocks at a discount, after all. If that 50% shocks you to the core and causes sleepless nights, then start saving more cash rather than selling the stocks you already own. This ratio is deeply personal and different for everyone - there is no right or wrong. Someone with more mouths to feed would probably be better to have more cash, while someone who has a very stable government job might need less on hand. The "right" amount of risk is the amount that keeps you in the market for the long term.