My argument is rather simple. I try to avoid taking risks on which I don’t know the bounds. My premise is that we can’t use the past to predict future risks of the extreme variety regardless of how we cook up the results because we don’t know what our errors are. So far, my only assumption is that risk comes suddenly, in jumps, and possibly worse than ever before. I can be 100% wrong here, and I’ll be safe. If I’m right, I’ll also be safe. My risk management paradigm goes like this. We know based on the limiting case that the risk associated with financial markets is always large, regardless of what it is right now or in the past. Just make sure that short of Armageddon (and US government debt default) nothing will hurt your finances.
Stock prices are probably not the determining factor in many people’s financial well-being. Most likely, the real estate prices are (and huge leverage most people use to buy houses). So to avoid losing lots of money the best way is to avoid buying a house with leverage. We know exactly what the risk is. So when millions of people default on their homes, even if I told them they are 100% likely to default, they would probably not do much about it until it happened to them. But even with stock prices, my paradigm works well. Just don’t put more than a fraction of your money in stocks, and you’ll be fine. Save over longer period of time, and you won’t need as much stocks as most people use. Control expenses and fees, and you’ll give yourself tens of thousands of $ in extra returns.
I think that the premise that you need stocks to save for retirement is flawed to the core. The answer is that you do not. What you do need is discipline that most people do not possess and/or do not acquire until its way too late, and then they start gambling away in a volatile stock market. Nothing will help these people. This is why financial planning is always more important than investment management (except as a way to make big money for the money managers, who are almost always the winners at the expense of the investors). Most people don’t need investment management as much as they need financial planning. Those who are good planners do not need to take much risk at all. It is very easy to decide how much risk is too much – just assume that you can lose 100% of the money invested in stocks, and you got yourself a limiting case.
Abstinence is the best birth control, risk avoidance is the best risk control. Everything else requires confidence which nobody can accurately provide, because this measure requires the use of past data, which is not very useful at all. I’m not advocating that we avoid all risk. What I am suggesting is that we try to avoid and/or hedge against those risks which have the potential to do us disproportional harm, especially the financial risks over which we have some degree of control (that is, we do not have to buy overpriced houses with leverage and we do not have to put all our money into high risk investments).