How a Military Career Can Increase Expected Investment Returns

Jake - Wealthy Corner Author/Founder

Jake - Wealthy Corner Author/Founder

Hi, I'm Jake. Life is hard enough without money stress. I help people under 40 take control of their finances and grow wealth to enhance freedom.

I discuss how a military career can increase your ability and willingness to take on risk. With more risk comes higher expected returns.

Joining the Canadian Armed Forces (CAF) at age 16 was the most beneficial event for my long-run investing returns. A military career has increased both my ability and willingness to take on risk, allowing me to achieve higher returns.

To be clear, higher expected returns, come from the ability and willingness to hold a more aggressive portfolio made up of nearly 100% equities (stocks). To get these returns, you need to have a long time horizon. Plus, you need to have the emotional readiness to hold on through nasty downturns. 

Risk and Returns

What is Risk?

Risk is the potential that you will lose money. It is commonly defined as the volatility of your portfolio – the intensity of ups and downs. We will stick with this definition for this post, although risk is a bit more nuanced. 

How Your Investments (Asset Allocation) Alters Risk

Since 1900, global stocks have outperformed global bonds by 3.1%/year (source). The reason for outperformance is that stocks have more risk than bonds. You get paid for taking on risk. This payment comes in the form of higher expected long-run returns.

You can control your risk exposure by changing the mixture of stocks and bonds in your portfolio. This mixture is called your asset allocation. And the only way to increase risk past that of 100% stocks is through the use of leverage, or by tilting your portfolio towards value stocks.

The historical returns of the various asset allocations for the past 50 years can be found in this Model Portfolio from the Canadian Portfolio Manager Blog. The higher the weighting towards bonds, the lower the returns.

One of the most important parts of investing is to engineer your asset allocation to match your unique ability and willingness to take on risk.

% Bonds% Stocks30 Year Annualized Return 
80%20%6.85%
60%40%7.33%
40%60%7.75%
20%80%8.11%
0%100%8.40%

Risk and Diversification

Diversification is the only free lunch in investing. You do not receive higher expected returns for taking on extra company-specific or geographic risk. So, I see no reason to take on risk that I will not get paid for. Global diversification removes risk specific to individual businesses or countries while leaving your expected returns unchanged.

Global diversification is the only free lunch in investing.

How Much Risk Can I Take?

Your risk tolerance depends on two unique factors:

  1. Your ability to take on risks; and
  2. Your willingness to take on risk.

Your ability to take on risk is rooted in your circumstances, while willingness to take on risk is based on your emotional sturdiness in the face of temporary financial loss.  Let’s dive into these two factors.

Ability to Take Risk

Your ability to take on risk is related to how much loss you can endure without ruining your financial situation. Your ability to take risk depends on:

  • Time Horizon – how long you can stay invested before you need the money;
  • Your Net Worth (Assets-Liabilities);
  • Mortgage debt;
  • Human Capital – Your future earnings power;
  • Income Stability; and
  • Savings Rate – A measure of income relative to expenses.

You can see the worst-performing historical periods for various asset allocations in this post. It give you an idea of why time-horizon is important, and what to expect for market downturns.

Willingness to Take Risk

Your willingness to take on risk is phycological. It’s how well you sleep at night in the face of market ups and downs. You can have the ability to take risk, but not the willingness.

If you don’t have the willingness to take risk, you may make errors that ruin returns, such as selling during downturns, or jumping into hype.

As your portfolio size grows, the up and down fluctuations will hurt more. So, willingness to take risk is more important as your portfolio increases in value.

Infographic: Emotional biases during COVID Crash

Willingness to take on risk is based on:

    • Your ability to understand your human biases; and
    • Your ability to control your human biases.

Ask yourself: What would  I do if I lose 50% of my investment portfolio in one year? If your response is to sell everything and never invest again, you do not have the willingness to take on the risk of 100% equities (stocks).

Estimate Your Asset Allocation

This Investor Questionnaire by Vanguard takes into account your ability and willingness to take on risk. From here it recommends an asset allocation that fits your unique risk profile. 

For CAF members, you can meet with SISIP Financial to get an idea of the right asset allocation for you. 

How Military Service Affects Your Ability to Take Risk

Pension

Your military pension is very nice. It’s expected to provide steady, inflation-adjusted cash flows during retirement.  Because you have a secure source of expected income in retirement, you could take on greater investment loss without ruining your retirement – it increases your ability to take risk.

CAF members contribute ~10% of their pre-tax income to the pension plan. This automated pension contribution is a form of forced savings.  I count these contributions towards my savings rate. 

In addition, the military pension can be treated as a “bond-like” asset. So, my 100% stock portfolio is really like a 70% bond, 30% equity portfolio once the pension is accounted for. I also count the pension towards my net worth using the transfer value.

Income Security

Your military income is stable and secure. You can predict next year’s income based on the CAF pay scales. Finally, the probability of layoffs is near zero, and your salary is likely to combat inflation.

These factors increase income certainty which allows you to plan better. It reduces the likelihood that you will be forced to sell your investments due to changes in income. It allows you to better ride out market turmoil.

Low expenses

Having a high savings rate – low expenses relative to your income – is a buffer to absorb financial blows. The cushion helps you to stay invested during downturns. You could even invest more aggressively during downturns when expected returns are highest.

I find the military sets us up to keep expenses low. Some examples include free gym, dental benefits, free pharmaceuticals, nil need to purchase work outfits and free lodging and rations on Temporary Duty. RHUs are also great if you are lucky enough to secure one. Here are 5 Ways a Military Career Helps me Keep Expenses Low. 

But this means nothing if you’re blowing your money on the newest BMW 3-Series. So, your own expense management abilities are the most important. In this post, I discuss why your savings rate is the most important personal finance metric.

How Military Service Can Increase Willingness to Take Risk

I wasn’t a disciplined kid. I may have gone down a bad path had I not joined the military at a young age. Service has shaped my character in a way that increases my willingness to take on risk.

My willingness to take on investment risk has improved due to:

  1. Self-discipline;
  2. An ability to remain calm;
  3. Suppression of ego (humility); and
  4. An understanding of self (conscientiousness).

The Military Trains Self-Discipline

We all associate discipline with the military. But we rarely ask why? Discipline is needed to control the military’s monopoly on lethal force. It’s needed to safely maintain aircraft and to ensure safety during dangerous training or operations.

Discipline is the regulation of natural short-term human tendencies that conflict with long-term goals. Relative to most civi organizations, the consequences to human life are greater in the military. Therefore, the military imposes higher standards to control natural normal short-term urges.

So, it’s clear why military training is designed to firm up self-discipline and character.

Self-Discipline and Your Willingness to Take Risk

The technical aspects of investing are simple. Evidence tells us to consistently invest in low-cost diversified stock and bond index funds that align with our asset allocation. The reality is that investing is simple, but hard – just like fitness.

The key to investing success is to control your human biases so that you can stick with the plan. Only by staying invested can you reap the rewards of compounded returns.

This means avoiding “get rich quick” urges, and combating the feelings of panic and fear during downturns. That requires self-discipline and the development of good habits and systems.

Emotional Biases

Your mission becomes controlling your human biases once you have confirmed your ability to take on risk. Taming your human biases can increase your willingness to take on risk. This is the hard part. These biases are strongest for young men – the primary demographic in the military. 

First, let’s dig into these common human biases: 

  • Loss Aversion – Losses hurt more than gains feel good. We chase high returns due to the Fear of Missing Out (FOMO). This urges us to chase returns, causing us to buy high and sell low.
  • Herding – Following the trending hype on social media, news, or Reddit. Similar to FOMO, herding causes us to buy high and sell low.
  • Overconfidence – We underestimate the role of uncertainty, and overestimate our skills and abilities. Overconfidence causes us to trade more frequently and limit diversification.

I write more about these three common emotional biases in this post, and here is another great article regarding emotional bias and investing.

It’s important to accept our weak areas and build systems to fortify these areas. Accepting these weak areas is hard. It requires self-discipline.

Zero Commission Trading, Investing Gamification: Self-Discipline is More Important Than Ever

Barriers to trading have recently declined through zero commission trading. This is great, however, zero-commission trading amplifies our natural urges towards short-term gratification.

In addition, gamification of investing with apps like Robinhood further increases the role of human bias. For example, this study shows that Robinhood facilitates intense herding episodes, and investor behavior on the platform hurts returns.

Infographic: Human Bias and Commission Free Trading

Good Investing is Boring

Good investing is boring. It’s characterized by slow and consistent compounding returns. Given time, compounding will make you wealthy. You need to be patient and stick with the plan for a long time – decades.

Because good investing is boring, it should not be a source of excitement in your life.  Excitement should come from elsewhere. A military career can provide this excitement, depending on the trade. For me, I  find excitement through work and mountain biking.

Remaining Calm: An Asset

Military service teaches us to remain calm during stressful circumstances. Long term investing can be an emotional roller-coaster. And demands on emotional strength increases as a portfolio grows in value.

For example, a big portfolio can fluctuate daily by an amount that exceeds your annual salary. This triggers loss aversion and other emotional biases that hurt returns.

Infographic: Volatility is the Price You Pay for Higher Returns

For example, over 90% of my portfolio is in equities (stocks). So, I’m down to ride out a 50% loss in portfolio value over 2-5 years, or a decade of zero real returns. If either scenario happens, I will continue to buy index funds and will stick with my plan. It’s useful to run through an exercise like this to determine your willingness to take on risk.

Leadership and Investing: Similarities

Good investors and good leaders have one thing in common – humility. They are both capable of suppressing their egos.

We naturally want to take more credit than we deserve when things go well, and we naturally like to shift the blame on external factors when things go wrong. Good leaders must suppress ego. Not only that, they often must go against what the ego suggests.

For example, good leaders push praise and credit for positive events to their subordinates, even when they played a role in the success. And they absorb responsibility for the mistakes of their subordinates. Both examples require humility and ego suppression.

The Role of Ego When Investing

Say you have a friend making crazy gains on crypto or a penny stock, and you are invested in index funds. While watching your friend make gains, you will feel FOMO, a form of loss aversion. Your ego will pull you to buy the asset and deviate from your plan. You need to suppress this urge, remain calm, and stick with your plan.

When you have a lucky investment outcome – like TSLA increasing by 700% in one year – it can breed overconfidence. It’s critical to understand the difference between luck and skill. If you attribute lucky outcomes to skill, you will become overconfident, and your ego will grow. Then, as your portfolio gets larger, you’ll be more likely to take on too much risk, which can cost your portfolio. I talk more about the difference between a good decision and a good outcome in this post: Decisions vs. Outcomes: The Dark Side of Lucky Investment Outcomes.

Conclusion

A military career has increased my expected returns by increasing my ability and willingness to take on risk. The more risk you can bear, the greater the expected long-term returns.

Regular Force military members have a unique ability to take risk due to the pension and income stability. The other factor – your willingness to take risk – is based on your ability to regulate your human biases. Self-discipline, shaped through service, can be helpful to increase willingness to take risk.

Finally, I find that leadership training and experience improves self-understanding and ego regulation. This, in turn,  regulates responses to feelings of FOMO and over-confidence while investing, preserving returns.