Taking risks like an Actuary

Yesterday I wrote a ridiculously abstract post about taking risks.  In it, I provided no numbers, no facts to back up my belief that taking risks can be worthwhile, particularly on things you truly desire.  Today, I’d like to try to bring it back to basics and talk numbers with you, especially with respect to Financial Independence.  So, let’s look at this whole risk process more like an actuary.  Don’t know what an actuary is?  Well, have you ever seen the movie Along Came Polly?  Basically, Ben Stiller’s character is an actuary.

Heavyweights remains my favorite Stiller film.  Dodgeball and Zoolander after that.  I think he only has two looks.

Heavyweights remains my favorite Stiller film. Dodgeball and Zoolander after that. I think he only has two looks.

In real life, an actuary tends to be someone who measures risk.  They have dive into massive amounts of data to figure out when people will die, how much money insurance companies need to have on hand in case of massive natural disasters, and will even determine what sort of asset allocation insurance companies should have in their portfolios.  Really, they are very, very, smart people (David Merkel at the Aleph Blog is one of my favorite guys in this arena.  While he isn’t an actuary, he’s worked with them all his life and understands the field).  And they are extremely good at figuring out if risks are worth it by utilizing math and logic.

So let’s take Financial Independence and think about that. That’s one of my constant themes around here and is something I’d like to achieve in the next ten years.  I’m obviously a ways away but still, I think about it.  But rather than look at the risks normally associated with quitting your job in order to live a stress-reduced life, let’s look at how our everyday choices can affect our goals.

I have a car payment that is $471 a month and I detest.  It takes away from my investments and I seriously want it to just go away.  In addition to this, I spend about $200 a month going out to eat, getting drinks with friends, etc.  This is hugely reduced from what it used to be (greater than $600 a month) but it still kills me to see it.  Beyond this, about $100 slips out of my hands every month somehow.  My guess is that the gnomes take it but more likely, it’s little things that just add up.  So, in total, I personally have wasted spending of $771 a month.  If I continue to waste this each month for ten years (not entirely realistic, since the car loan is paid off in another four or so but bear with me) I will have missed out on a full $142K in principal and investment gains.  That right there could mean the difference between retiring in ten years and retiring in fifteen.  That’s not an insignificant number!!

But that’s just me.  Let’s look at someone else.  Let’s take a coffee habit into account here.  Let’s say that Sally gets a coffee every workday, Starbucks, and it costs her $5 total.  Sally works 50 weeks out of the year so she’ll average just about $105 a month.  Sally isn’t interested in Financial Independence so she works for 40 years and retires.  How much money did Sally end up losing?

$369K.  She lost $369K dollars in 40 years.  And truth be told, it will actually be more.  Forty years ago, a cup of coffee cost a fraction of what it costs today.  In forty years, assuming constant inflation of 3%, it will cost $16!!  So really, Sally will lose WAY more than $369K in real dollars.  But in 2013 dollars, it’s close.

The point is that in the long run, every decision we make, whether small or large, has a consequence.  Every dollar could and should be invested and put to work for you, earning you more money while you are off doing something else, getting you closer to your goals.  Every $100 we spend is worth $220 in ten years.  That adds up each and every month.  We need to scrutinize every dollar we spend and ask ourselves “does this help me?”  If the answer is “no” or “I don’t know” then put the card or the cash away.  If you’re going to take risks, take cheap ones!  Like cliff diving

Yup, it's actualy me!  And yes, Cliff Diving is awesome and everyone should try it.  Just, you know, don't get hurt.  That's when it starts costing you money.

Yup, it’s actualy me! And yes, Cliff Diving is awesome and everyone should try it. Just, you know, don’t get hurt. That’s when it starts costing you money.

One thought on “Taking risks like an Actuary

  1. “I spend about $200 a month going out to eat, getting drinks with friends, etc. This is hugely reduced from what it used to be (greater than $600 a month) but it still kills me to see it.”

    Of course, the cheapest option would be to live like a hermit and never go out and socialize. We don’t go out often, but it is nice to spend time with people who aren’t dressed in orange and yellow (safety vest & hardhat) from time to time.

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