The cost of being wrong has gone up.

My partner, Tim Macarak, CFP®, wrote this week in a Good Family Fight about the Federal Reserve's decision to hold interest rates steady and the bond market's less-than-enthusiastic response. I wanted to build on that conversation because I think it points to something broader.

At almost the same time the bond market was reacting to the Fed, another story caught my attention.

Despite being only 25 years old, Leopold Aschenbrenner built one of the most closely watched investment firms of the artificial intelligence era in just two years. His hedge fund, aptly named Situational Awarenessⁱ produced extraordinary early returns, grew to roughly $20 billion in assets, then levered those positions to approximately $45 billion through concentrated bets tied to the growth of AI.

Then technology and semiconductor stocks fell sharply.

According to recent reporting, the fund suffered significant losses, reduced positions and sought additional capital. The same leverage that magnified its gains was now limiting its ability to wait for the investment thesis to recover.

Aschenbrenner may ultimately prove correct about artificial intelligence. We happen to believe AI will transform nearly every part of the economy as well.

But being right about the next decade does not protect you from being forced to sell next week.

That is the danger of leverage. The problem is not borrowing. The problem is borrowing so much that you lose the ability to wait. That lesson extends well beyond hedge funds.

It helps explain why today's interest-rate environment deserves investors' attention.

The Federal Reserve did not raise rates. It did not cut them either. Yet longer-term interest rates moved higher, with the yield on the 30-year Treasury reaching levels last seen before the 2008 financial crisis. The bond market seemed to be saying that, with economic growth holding up and inflation still elevated, maintaining the same short-term rate may not be enough.

Sometimes markets tighten financial conditions even when the Federal Reserve does not.

That is where the term bond vigilantes comes from. When investors become concerned about inflation, government borrowing or the credibility of monetary policy, they can demand higher yields to lend money for long periods of time. Policymakers may set short-term interest rates, but they do not entirely control the cost of a 10-, 20- or 30-year loan.

Whether the bond vigilantes have truly returned remains to be seen.

Not because we believe a crisis is imminent. Not because we are calling the top of the stock market. And certainly not because we believe investors should abandon long-term plans whenever markets become uncomfortable.

We are paying attention because the cost of being wrong has gone up.

When Money Was Nearly Free

For much of the decade following the financial crisis, interest rates were exceptionally low.

Cash earned almost nothing. High-quality bonds did not offer much more. Investors were repeatedly encouraged to move farther out on the risk spectrum in search of return.

That environment made many mistakes easier to survive.

A business could operate for years without producing a profit because capital remained available. Investors could hold highly speculative assets without giving up much income elsewhere. Real estate projects could be financed cheaply. Companies could borrow to repurchase shares. Private funds could use leverage to enhance returns. Families felt less urgency to pay down variable-rate debt because the cost of carrying it was modest.

Time was cheap. Money was cheap. Waiting was cheap.

Today, none of those things is quite as cheap as they used to be.

When cash and high-quality bonds offer meaningful yields, every other investment has a higher hurdle to clear. Owning gold, cryptocurrency, a richly valued non-dividend-paying stock or an early-stage business may still prove rewarding. But the opportunity cost is different when an investor can earn a reasonable return without assuming the same level of uncertainty.

The existence of a safer alternative does not make risk-taking wrong.

It raises the cost of being wrong.

Risk Has a Time Horizon 

One of the most overlooked forms of investment risk is not what you own.

It is when you will need the money.

A portfolio can be perfectly reasonable for the next 20 years and completely inappropriate for the next two.

Consider a family with a child starting college in two years. Money that will soon be needed for tuition does not have the same time horizon as money intended for retirement decades from now.

This is a good time to review the equity exposure inside a 529 plan. Make sure the next several years of expected tuition payments are not entirely dependent on the stock market cooperating. For near-term expenses, an appropriate combination of cash and high-quality bonds may be more important than maximizing potential returns.

The same principle applies to retirement.

For someone 20 years from retirement, a significant market decline may be painful, but time can be an ally. Continued savings, reinvested dividends and future market recoveries provide room to adjust.

For someone planning to retire within five years, the calculation changes.

We saw this in 2007, 2008 and 2009. Some people who expected to retire around 2010 had to delay their plans because the assets they would soon need were exposed to too much market risk.

They may not have had too much risk for the remainder of their lives.

They had too much risk for the next three years.

That distinction matters.

Risk is not just the possibility that an investment falls in value. Risk is also the possibility that it falls at the exact moment you need to sell it.

The first several years surrounding retirement can have an outsized effect on whether a financial plan succeeds.

That does not necessarily mean reducing equity dramatically. It may mean identifying the money needed during the early years of retirement and protecting that portion differently. It may mean holding more cash, using high-quality bonds or creating a dedicated source of near-term spending.

The goal is not to predict the market.

The goal is to avoid making the success of your retirement dependent on the market being kind at precisely the right moment.

You Do Not Have to Leave Equities to Reduce Risk

Over the past several months, our investment team has been reviewing our investment strategies internally and speaking directly with the managers we employ.

We have become incrementally more cautious than we were six or 12 months ago.

That does not mean we are abandoning equities. It does not mean we expect the market to fall by a particular amount. It means we are looking more carefully at where risks have accumulated after several strong years, one of the strongest rolling three-year periods in the history of the S&P 500.

One of those areas is concentration.

Many investors own more of the largest technology and AI-related companies than they realize. They may own them directly, through index funds, through actively managed funds and again inside retirement accounts. What appears to be a diversified collection of investments can sometimes be several versions of the same underlying exposure.

You do not always have to reduce your overall equity allocation to reduce risk.

You can diversify within equities.

You can reduce a concentrated individual position. You can balance one investment style with another. You can diversify across company sizes, industries and regions. You can make sure that several funds in a portfolio are not all relying on the same handful of stocks.

For investors who have spent years avoiding capital gains taxes, this may also be an appropriate time to revisit whether the tax tail has begun wagging the investment dog.

Taxes matter. We spend a great deal of time helping families manage them intelligently.

But indefinitely deferring a tax bill is not always the same as reducing risk. Sometimes paying a known tax today is the reasonable price of reducing a concentration that could threaten a much larger portion of your wealth tomorrow.

At Members' Wealth, we call this Wealth Done R.I.T.E.—integrating Risk, Investments, Tax and Estate planning because financial decisions rarely exist in isolation.

We do not know where interest rates will be next year. We do not know whether the stock market will be higher or lower.

What we do know is that today's environment offers less margin for error than the one investors enjoyed for much of the past decade.

Interest rates are higher. Cash and high-quality bonds once again earn meaningful returns. Leverage is more expensive. Markets remain concentrated. The opportunity cost of every financial decision has changed.

We cannot eliminate uncertainty.

We can build portfolios—and financial lives—that do not require everything to go exactly right.

When the cost of being wrong goes up, margin for error becomes one of your most valuable assets.

 ⁱ Aschenbrenner's famous essay, Situational Awareness, argued that society was dramatically underestimating how quickly AI would advance. His thesis was essentially: I see what's coming before others do. He named his hedge fund after that idea.  

Investment strategies, including rebalancing, do not guarantee improved performance and involve risk, including potential loss of principal. Past performance does not guarantee future results.

The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. 
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.

About the Author

Dane Czaplicki, CFA®

Dane Czaplicki is CEO of Members’ Wealth, a boutique wealth management firm that offers a comprehensive approach to serving individuals, families, business owners, and institutions. The firm’s goal is to preserve and grow its clients’ wealth to endure over time, while thoughtfully evolving its strategy to suit an ever-changing world. With over 20 years of wealth management experience, Dane and the Members' Wealth team thrive on bringing clarity and confidence to clients' unique situations. He believes everyone needs sound financial advice from someone whose interests are aligned with theirs, and is determined to put service before all else.

Dane received his MBA from The Wharton School of Business at the University of Pennsylvania and his bachelor’s degree from Bloomsburg University. Outside work, he enjoys spending time with his wife and kids, hiking and camping, reading, running, and playing with his dog. To learn more about Dane, connect with him on LinkedIn.

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