Perceived Risk vs. Actual Risk

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Image via Pexels: Fernando Arcos

By Michael J. Wiener

Special to Financial Independence Hub

We often see debates about whether or not volatility of returns is a good measure of risk.  This debate is related to what I think is a bigger issue: the difference between perceived risk and actual risk.  Perceived risk is influenced by observations and “dollar bias,” but actual risk comes from the full range of what might happen and its influence on buying power.

Dollar bias and buying power

In some contexts we forget about inflation and view dollars as constant over time.  For example, we tend to focus on nominal returns and think that it’s okay to spend gains as long as we leave the principal intact.  But the principal will erode with inflation if we spend all the nominal gains.

Another context where we see this bias is with mortgages.  We can calculate that with a 30-year $400,000 mortgage at 4%, the first year’s payments will only reduce the principal by about $7000.  But even with only 2% inflation, the buying power of the principal will erode by about $8000, and the fixed payments will become easier to make with rising salaries.  Homeowners are making more progress than they think.  If they can keep up the payments, inflation will eventually take care of both the principal and fixed payments.

Observations and what could have happened

It’s natural to be most worried about the things that we’ve seen happen, but there are many more things that could have happened.  Just because some employees invested everything they had in their employer’s stock and it worked out well doesn’t mean that it was a good idea.  If the employer had stumbled, the employees might have lost their jobs and all their savings at the same time.

The way we measure volatility of returns is often by looking at past returns over some period like a decade and calculating their standard deviation.  But this doesn’t capture what might have happened.  Measured volatility might reflect actual risk some of the time, but we’re guaranteed to have quiet periods with low measured volatility even though actual risk remains higher.

We see this at casinos all the time.  Craps tables sometimes appear to be “hot” with everyone making money, but in reality, the odds never change.  It’s not safer to gamble at craps when a table has been hot for a while.

Any investment strategy that tries to optimize leverage using measured volatility of past returns is destined to blow up after a period where measured volatility is much lower than actual risk.  This fact played a role in both the implosion of Long-Term Capital Management (LTCM) in 1998 and in the Global Financial Crisis of 2008.

Nassim Taleb’s parable of the turkey nicely illustrates the big difference between past experience and what could happen in the future.  A turkey might think that life is wonderful with all of its needs being met.  It never anticipates that fateful day when it becomes someone’s dinner.

Lessons

Actual risk is what might happen to the buying power of our savings.  It is not just what we’ve observed happen to our nominal savings in the past.  Here are some lessons we can take from these facts:

  1. Focus on buying power, not dollars.  The main way we get into trouble with dollar bias in investing is when we think long-term bonds are safe because they preserve principal.  Over long periods, inflation can be devastating, particularly when it rises unpredictably.  Long-term bonds are much riskier than they appear.
  2. There are risks out there that we can’t anticipate.  Whatever level of risk you decide is right for you based on the risks you can anticipate, it’s likely that you’d be better off with a little less risk.  This line of reasoning is often used to tell people to shift their portfolios a little away from stocks and more to bonds, but remember that long-term bonds are risky.  Sometimes the best way we can deal with unknown financial risks is to save a little more.
  3. Any financial plan that adapts to measured past return volatility is likely flawed.  If you’re into the weeds thinking about the Kelly criterion and Sharpe ratio of your portfolio, you’re probably on the wrong path.

Michael J. Wiener runs the web site Michael James on Money, where he looks for the right answers to personal finance and investing questions. He’s retired from work as a “math guy in high tech” and has been running his website since 2007.  He’s a former mutual fund investor, former stock picker, now index investor. This blog originally appeared on his site on  Sept. 8, 2025 and is republished here with his permission

Why Cash Flow Management is the Key to Early Retirement

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Image by Pexels: Tima Miroshnchenko

By Kylie Ann Martin

Special to Financial Independence Hub

The dream of retiring early is no longer a niche pursuit reserved for the ultra-wealthy. Thanks to the Financial Independence, Retire Early (FIRE) movement, thousands of professionals are restructuring their lives to exit the traditional workforce decades ahead of schedule.However, many aspiring retirees focus exclusively on their “magic number” — the total net worth required to stop working.

While having a significant nest egg is crucial, the true engine of a sustainable early retirement is not the size of the pile, but the efficiency of the flow.

Early retirees must plan for 40 to 60 years of living expenses, navigating market swings, inflation, and longevity risk. A smart strategy for tracking, adjusting, and optimizing income and withdrawals is what keeps your portfolio lasting — and your freedom intact — long after you leave the traditional workforce.

The Shift from Accumulation to Distribution

For the majority of an individual’s career, the focus is on Accumulation. You earn a salary, minimize expenses, and invest the surplus into growth-oriented assets. The upward trajectory of your net worth measures success.

The moment you retire early, the game changes entirely. You move into the Distribution phase, where the primary objective is no longer growth at all costs, but the consistent generation of liquidity to fund your lifestyle.

The challenge of early retirement is that your assets must serve two masters: they must provide enough cash for today’s bills while continuing to grow enough to outpace inflation for the next half-century. This transition requires a psychological and mechanical shift.

You are no longer “saving” for the future; you are managing a private endowment where the “yield” must be carefully harvested without killing the “golden goose.” Learning how to balance your inflows and outflows effectively is the first step in making this mental leap from a steady paycheque to self-funded sustainability.

Managing the Sequence-of-Returns Risk

One of the most significant threats to early retirement is “Sequence of Returns risk,”which is the danger that the stock market will experience a major downturn in the first few years of your retirement.

If you are forced to sell stocks to pay for living expenses when the market is down 20%, you are effectively locking in those losses and depleting your principal at an accelerated rate.

Effective cash flow management mitigates this risk by ensuring you never have to sell equities during a bear market. You can achieve it through a “bucket strategy” or a cash buffer. Many financial experts suggest streamlining your liquid assets by keeping two to three years’ worth of living expenses in low-volatility accounts.

When the market is up, you replenish the cash bucket from your gains; when it is down, you live off the cash and give your portfolio time to recover.

Strategies to Make your Money Last

To thrive over a 40-year retirement horizon, you need a dynamic withdrawal strategy. Rigidly adhering to a “4% rule” may not be enough if inflation spikes or market conditions remain stagnant for a decade.

A proactive approach to spending in retirement involves creating “guardrails”—predefined rules that dictate when you should belt-tighten and when you can afford a luxury purchase.

Dynamic spending adjustments

Instead of withdrawing a fixed amount adjusted for inflation, dynamic spending allows you to reduce your “paycheck” during market dips. This preservation of capital during downturns is one of the most effective ways to extend the life of a portfolio.

The role of yield-producing assets

Diversifying into assets that provide natural income — such as real estate or dividend-paying stocks — helps bridge the gap between your needs and your portfolio’s growth. This reduces the friction of selling assets and provides a more predictable monthly floor for your budget. Continue Reading…

Three Ways Life Insurance can Protect you from Inflation

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Photo courtesy LSM Insurance

By Lorne Marr, LSM Insurance

Special to Financial Independence Hub

Inflation means the prices of everyday things — like food, housing, transportation, and healthcare — increase over time. This reduces the purchasing power of your money and can affect your family’s standard of living. Permanent life insurance can be a powerful tool to help protect your finances against these rising costs.

What type of Life Insurance helps with Inflation?

Permanent life insurance provides lifelong coverage and builds cash value over time. Unlike term life insurance, which only covers a specific period, permanent policies can grow in value and death benefit, helping your family maintain financial security despite inflation.

Main types of permanent life insurance:

  • Whole Life Insurance
    • Provides a guaranteed death benefit and builds cash value.
    • Participating whole life policies pay dividends, which can buy Paid-Up Additions (PUAs)—small increments of additional insurance that increase both death benefit and cash value.
  • Universal Life Insurance (UL)
    • Flexible premiums and death benefits.
    • Option to choose a level death benefit or an increasing death benefit to keep up with inflation.

There are three main ways permanent life insurance can protect you against inflation:

1. Inflation Protection through Increasing Death Benefit Option in Universal Life Policies

How it works: Your death benefit can grow over time to match inflation.

Example (2% inflation):

By choosing an increasing death benefit, your coverage keeps pace with inflation, preserving purchasing power for your family.

2. Inflation Protection through Participating Whole Life Insurance and Paid-Up Additions

How it works: Dividends from a participating whole life policy can purchase Paid-Up Additions (PUAs), increasing both death benefit and cash value over time.

Example (2% inflation, PUAs $12,000/year):

With 2% inflation, the original $500,000 loses value to $452,000 in today’s dollars. PUAs grow your policy above this, effectively protecting your family against inflation. Continue Reading…

What is Market Timing Theory?

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Market timing theory attempts to interpret and detect buy and sell signals in trading patterns and history

TSInetwork.ca

Market timing theory is an investment strategy based on the belief that investors can identify optimal times to enter or exit financial markets by predicting future market movements using technical analysis, economic indicators, or other forecasting methods.

The practice of market timing consists of coming up with and acting on a series of guesses (or estimates, or probability assessments) to use in your buying and selling decisions. The aim is the same in 2026 as it was in 1997 when the strategy gained prominence: to buy near a low and sell near a high. Market timing theory attempts to interpret and detect buy and sell signals in trading patterns and history. Some of the decisions you make with the help of market timing will bring you profits, and others will cost you money.

Many investors start out with an exaggerated idea of the value and importance of market timing. Most eventually become disillusioned with it, after they figure out that it’s costing them money.

Market timing can pay off sporadically, of course. Although the results are largely random, successes and failures are apt to come in spurts. The worst thing that can happen to you near the start of an investing career is that you make a series of successful timing decisions. This may lead you to believe that you have a natural talent for market timing, or that you’ve stumbled on a timing process that’s a guaranteed money-maker. Either of these conclusions can spur you to back your future timing decisions with growing amounts of money.

Good timing-based decisions often produce modest profits. They tend to be smaller than the losses you get from bad timing decisions. Needless to say, one of your future decisions is bound to turn out bad. If you’ve invested enough money in it, you could wind up losing much more than your accumulated winnings from prior timing-based decisions.

What are the key principles of market timing?

The key principles of market timing theory include:

  1. Market Predictability: The foundational belief that financial markets follow discernible patterns that can be identified and exploited through various analytical methods.
  2. Risk Management: The goal of reducing exposure during market downturns by moving to cash or defensive assets, potentially preserving capital that would otherwise be lost.
  3. Enhanced Returns: The aim to outperform buy-and-hold strategies by capturing market upswings while avoiding significant downswings.
  4. Signal Identification: Using technical indicators (like moving averages, MACD, RSI), fundamental data (economic indicators, interest rates), or sentiment measures to generate buy/sell signals.
  5. Pattern Recognition: Identifying recurring market behaviors such as support/resistance levels, trend formations, or historical cycles that might predict future price movements. Continue Reading…

Four Horsemen of the Apocalypse?

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Image by Pixabay

By John De Goey, CFP, CIM

Special to Financial Independence Hub

Over the past number of months, I have become increasingly interested in a series of ideas put forward by a handful of economists who were both iconoclastic and influential in their time.  It seems their ideas are experiencing a bit of a renaissance. Some of these economists achieved moderate fame, and some had more credibility than others.

Here I’d like to explore the related theories and ideas of Joseph Schumpeter, Nikolai Kondratieff, Simon Kuznets and Hyman Minsky.

Let’s begin with portraits of the four thinkers

Joseph Schumpeter (1883-1950) — His big idea was ‘creative destruction,’ the notion that capitalism advances through waves of entrepreneurial innovation that destroy old industries and create new ones, driving productivity growth though with upheaval for incumbents.

Nikolai Kondratiev (1892 – 1938) — Held the view that ‘long waves’ (lasting roughly 50–60 years) explain how economies experience ‘super cycles’ that are tied to major technological revolutions (e.g., steam/rail, electricity/chemicals, information) that reshape investment, growth, and prices. The current wave has been dominated by the internet and artificial intelligence and likely started in the mid to late1980s.

Simon Kuznets (1901 – 1985) — Wrote about structural change and long-run growth. He felt that the economy reorganizes itself across sectors and shifts in income distribution accompany growth. He was among the first to write about income inequality and the structural changes he identified matter for things like productivity and living standards.

Hyman Minsky (1919 – 1996) — Is best known for his financial instability hypothesis: stability breeds complacency; credit cycles move through hedge, speculative, and ponzi financing, causing systemic fragility and crises when optimism turns to debt distress, leading to a “Minsky Moment” when it all comes crashing down. Over-extended credit leading to a collapse in prices was a major factor in the dot.com crisis and the global financial crisis of 2007-09.

What these ideas have in common is intuitively obvious from an ‘eye test’ perspective. Still, the concepts are difficult to explain reliably using econometric data. In many instances, these men were mocked because their theories didn’t fit neatly into how the world was perceived, but all four have left a mark on how we interpret information in the 21st century.

The reason I’m running into their ideas more and more these days is that there’s as strong consensus among their adherents that their related theories are relevant again based on recent developments. They seem to be converging and so may ultimately amplify one another if the waves coincide.

The unifying theme is that growth is not just a smooth upward trend, but rather something that is driven by transformative forces that reorganize both production and finance. Innovation and technology have long been accepted as central engines of change, but their effects spill over into organizational forms, institutions, and credit. Furthermore, it seems long-run development is layered, meaning that broad technological shifts (i.e., long waves) interact with shorter sectoral shifts. The overlay of these disparate waves can amplify or dampen economic outcomes.

Bringing together four influential strands in economic thought, we can attempt to sketch a cohesive framework that explains long-run growth, structural change, and financial instability as different facets of a single dynamic process: innovations drive new opportunities, which reshape the economy’s structure and distribution, while finance amplifies and sometimes destabilizes that process.

The four thinkers illuminate different angles of a single dynamic: innovation drives growth and structural transformation; the financial system amplifies this process but can sow instability; long-run waves reflect broad technological revolutions, while distributional changes concern who benefits.

A cohesive Dynamic Innovation–Structure–Finance framework captures how technology, sectoral change, credit, and policy interact across time to produce growth, inequality, and crises. It suggests a prescription of balanced policies that nurture innovation while guarding against financial fragility. The economy evolves through the interaction of four interdependent engines: Technology/Innovation, Structural Change, Finance, and Policy/Institutions.

Let’s look at the mechanisms and phases in more detail

Long Kondratiev Wave:

Each wave is anchored by a broad technological revolution (historical examples include steam/rail, electricity/chemicals, information/communication:  the latest is internet / AI). Each wave drives sustained investment, productivity gains, and demographic/urban changes.

Mid-cycle Kuznets Structural Shifts: Continue Reading…