Lifetime Consumption!

When it comes to investing, most people are risk-averse!

Given the expected return, they prefer lower risk, and given the level of risk, they prefer higher expected return. Though, the definition of risk changes basis people’s experiences, volatility of the asset, etc.

Dartmouth finance professor Kenneth R. French defined risk as uncertainty about lifetime consumption broadly defined.

People generally invest to realize their gains or wealth in the future. People might plan to spend all the money on themselves for things like food, shelter, travel, recreation, and medical care or to give away and donate to charities.

So the definition of lifetime consumption includes all these and any other anticipated uses of wealth.

Investors like a high expected return because it increases the expected wealth that will be available to spend or give away. And everything else the same, risk-averse investors prefer less uncertainty about their future wealth.

How can we manage or reduce the risk of lifetime consumption?

Liability-driven investing is one of the ways to manage the uncertainty about lifetime consumption. List out your major consumptions across years & invest considering how potential investment will vary with your existing portfolio and with your other sources and uses of wealth.

For example, if one is stretching to buy the first home, one might move the savings you will need at closing into a safe money market account today.

The takeaway here is to think about risk holistically and understand how will it affect the uncertainty about your lifetime consumption at different intervals.