Understanding the phrase "afford to lose" better

Question

The phrase, "Only invest what you can afford to lose", when put in quotes, generates 167,000 Google hits and seems to me like one of the hoariest maxims in investing. But what does it mean?

Obviously, something like this is open for subjective interpretation--a no-no for SE sites. But is there any reasonably objective understanding of what "afford" means here? Such as common investing or personal finance conventions (bolstered by economic data or theory) about a specific value for how much "afford to lose" means?

For various toy examples...you could "afford to lose..."

• everything but a six month emergency fund--at any age.
• all but x% of your current wealth, where x is the answer to an age-based equation.
• no more than five years' worth of net earnings.
• etc...etc...

Also, most asset allocation prescriptions I see suggest a youngish person (say, 40) should be essentially invested 100% in something with risk, with very little guaranteed investments like CDs, other than that famous six month emergency fund. But if one is invested close to 100%, what happened to "only invest what you can afford to lose"?

My feeling is there is something incoherent about this maxim, and I'm hoping the forum can help shine objective light on it by referencing tested ideas or micro-economic theories about it.

Answer 1

Well....

If you have alllll your money invested, and then there's a financial crisis, and there's a personal crisis at the same time (e.g. you lose your job) then you're in big trouble. You might not have enough money to cover your bills while you find a new job. You could lose your house, ruin your credit, or something icky like that. Think 2008. Even if there's not a financial crisis, if the money is in a tax-sheltered retirement account then withdrawing it will incur ugly penalities.

Now, after you've got an emergency fund established, things are different. If you could probably ride out six to twelve months with your general-purpose savings, then with the money you are investing for the long term (retirement) there's no reason you shouldn't invest 100% of the money in stocks. The difference is that you're not going to come back for that money in 6 months, you're going to come back for it in 40 years.

As for retirement savings over the long term, though, I don't think it's a good idea to think of your money in those terms. If you ever lose 100% of your money on the stock market while you've invested in diversified instruments like S&P500 index funds, you're probably screwed one way or another because that represents the core industrial base of the US economy, and you'll have better things to worry about, like looking for a used shotgun. Myself, I prefer to give the suggestion "don't invest any money in stocks if you're going to need to take it out in the next 5 years or so" because you generally shouldn't be worried about a 100% loss of all the money in stocks your retirement accounts nearly so much as you should be worried about weathering large, medium-term setbacks, like the dot-com bubble crash and the 2008 financial crisis. I save the "don't invest money unless you can afford to lose it all" advice for highly speculative instruments like gold futures or social-media IPOs.

Remember also that while you might lose a lot of your money on the stock market, your savings accounts and bonds will earn you pathetic amounts by comparison, which you will slowly lose to inflation. If you've had your money invested for decades then even during a crash you may still be coming out ahead relative to bonds.

Answer 2

It's a phrase that has no meaning out of context. When I go to Las Vegas (I don't go, but if I did) I would treat what I took as money I plan to lose. When I trade stock options and buy puts or calls, I view it as a calculated risk, with a far greater than zero chance of having the trade show zero in time.

A single company has a chance of going bankrupt. A mix of stocks has risk, the S&P was at less than half its high in the 2008 crash. The money I had in the S&P was not money I could afford to lose, but I could afford to wait it out. There's a difference. We're not back at the highs, but we're close.

By the way, there are many people who would not sleep knowing that their statement shows a 50% loss from a prior high point. Those people should be in a mix more suited to their risk tolerance.

Answer 3

The way I approach "afford to lose", is that you need to sit down and figure out the amount of money you need at different stages of your life.

I can look at my current expenses and figure out what I will always roughly be paying - bills, groceries, rent/mortgage.

I can figure out when I want to retire and how much I want to live on - I generally group 401k and other retirement separately to what I want to invest. With these numbers I can figure out how much I need to save to achieve this goal.

Maybe you want to purchase a house in 5 years - figure out the rough down payment and include that in your savings plan. Continue for all capital purchases that you can think you would aim for.

Subtract your income from this and you have the amount of money you have greater discretion over. Subtracting current liabilities (4th of July holiday... christmas presents) and you have the amount you could "afford to lose".

As to the asset allocation you should look at, as others have mentioned that the younger you the greater your opportunity is to recoup losses. Personally I would disagree - you should have some plan for the investment and use that goal to drive your diversification.

Answer 4

Keep in mind that it's a cliche statement used as non-controversial filler in articles, not some universal truth. When you were young, did you mom tell you to eat your vegetables because children are starving in Ethiopia? This is the personal finance article equivalent of that.

Generally speaking, the statement as an air of truth about it. If you're living hand to mouth, you probably shouldn't be thinking about the stock market. If you're a typical middle class individual investor, you probably shouldn't be messing around with very speculative investments.

That said, be careful about looking for some deeper meaning that just isn't there. If the secret of investment success is hidden in that statement, I have a bridge to sell you that has a great view of Brooklyn.

Answer 5

I think that people only use the phrase "only spend what you can afford to lose" when they are talking about the most risky or speculative investments, or even gambling.

When talking about gambling, the following quote is a bottom line:

Next week's rent, the money for your car loan, and money that isn't strictly
yours to spend are all examples of money you can't afford to lose.

The speculative investment that brought me to this question via google is how much should I invest in Bitcoin? I was tempted to put in 10% of my investments, not including the 6 month safety fund and not including equity in my home. Now thinking about this question, it seems that it depends on your income as a percentage of your investment income (which should grow in proportion to the whole over time). For example:

Early stage of career, not much investment income: 20% Mid career: 5% Mid-late career, moving to more safe investments: 5% Late career, retirement: 1%

Another way to calculate would be as a percentage of the amount you put into retirement savings per year. Maybe 10% of this figure when you're young and 1% nearer to retirement.

Answer 6

The advice to "Only invest what you can afford to lose" is good advice. Most people should have several pots of money: Checking to pay your bills; short term savings; emergency fund; college fund; retirement.

When you think about investing that is the funds that have along lead time: college and retirement. It is never the money you need to pay your bills.

Now when somebody is young, the money they have decided to invest can be in riskier investments. You have time to recover. Over time the transition is made to less risky investments because the recovery time is now limited. For example putting all your college savings for your recent high school graduate into the stock market could have devastating consequences.

Your hear this advice "Only invest what you can afford to lose" because too many people ask about hove to maximize the return on the down payment for their house: Example A, Example B. They want to use vehicles designed for long term investing, for short term purposes. Imagine a 10% correction while you are waiting for closing.

Answer 7

I think it's a silly statement. If you are prepared from the start that you might lose it then you shouldn't invest. You invest to earn not to lose. Most often losses are a result of fear. Remember you only lose when you sell lower than you bought for. So if you have the patience you will probably regain. I ask my clients many times how much do they want to earn and they all say "as much as possible". Last time I checked, that's not an objective and therefore a strategy can't be built for that. If there is a strategy then exiting a stock is easy, without a strategy you never know when to exit and then you are exposed to bottomless losses. I've successfully traded for many years with large amounts of money. I made money in the FC and in the bubble, both times it wasn't because I was prepared to lose but because I had an entry and exit strategy. If you have both the idea of investing what u are prepared to lose has little value.