Posts made in April 2021

“Investments involve risk.” 

Not a new concept for anyone who’s ever heard or seen a commercial from any financial adviser. But have you ever stopped to consider what risks they are talking about or how you can mitigate them in through your investment strategy? 

In our last three posts, we talked about not following the crowd, buying value and diversification. Each is part of a risk mitigation strategy but determining the right amount of risk to take is the first step in the process. And that is what we will be discussing in this post.  

Types of Risk 

Tolerance to risk varies from investor to investor and is a very personal decision. However, there are common elements that each investor should take into account. The two most common are systematic and unsystematic risk.  

Systematic risks are those that have effects on the entire market. Things such as wars, pandemics, and recessions are most common. Unsystematic risks are those that affect individual stocks and securities.  

If you take too much risk, your portfolio is susceptible to marketing swings and may not leave you enough time to recover before having to begin withdrawals. On the other hand, if you don’t take enough risk, you could be missing out on long-term gains, leaving your portfolio vulnerable to inflation.  

Portfolio diversification can help mitigate both systematic and unsystematic risks by dividing your eggs among several baskets, protecting the overall value from marketing swings.  

Getting Personal 

Here’s where risk becomes personal, and you need to be honest about how much risk you are willing to take. No one wants their portfolio to lose money, but we all know that it will go up and down over time, so you need to ask yourself a couple of questions.  

First, with your long-term goals in mind, do you could withstand swings in value and take the loses in order to pursue the returns. Second, how much risk is necessary in order to meet your goals. The answer to the first question lies within you, while the second can be answered by examining several factors. These include your expectations for return, investment objectives, time horizon and appetite for risk.  

There are asset allocation tools you can use to help you determine the optimal level of risk and many of the most popular begin their calculations by considering your age or time until retirement. While both factors are useful, they are by no means the only and not even the most critical. Other factors to consider are your liquidity needs, net worth and investing priorities.  

Take for instance the idea of decreasing investments in equities and increasing fixed income holdings as you approach retirement age. On its face, the strategy seems not only reasonable but perfectly logical, as well. However, if your allocation strategy is based on age, it is likely that it has not considered longer lifespans, and the effects of inflation. Ignoring both can put you at risk of running out of money.  

 Conclusion  

Risk tolerance is a tricky thing to determine because it requires being honest with yourself and, if you don’t get it right, you could be leaving yourself open to missing out on gains or living through wild swings in portfolio value that have you reaching for the antacid.  

Finding a financial planner to help you figure out what level of risk is right for you is a worthwhile investment of time and money.  

nvesting is for the long term. There is little return in trying to “time the market” based on trends or the economic outlook. The key element focused on by the savvy investor is value. And the value of an investment vehicle is created over time.  

Think about the various funds you’ve considered investing in and what matters most to you; do you go to the six-month performance or the two-year. Six months will give you a snapshot, but two years will show you historical performance.  

Market Trends 

The savvy investor considers market trends but knows that trends alone are meaningless. The same is true with the economy. While the overall economy took a huge hit in 2020 with unemployment spiking and thousands of businesses permanently shuttered because of the pandemic, the stock market seemed unfazed. The Dow and S&P 500 ended the year at record highs while the NASDAQ had its best return in 11 years.  

While that might seem counterintuitive to most, it’s not unusual for the economy and the markets to trend in opposite directions. What’s more, the opposite is also possible with the economy growing during a bear market. And, as with everything, trying to predict what is going to happen and when is a fool’s errand, making value the most important factor when investing.  

This is not to say that market and economic trends are not important. On the contrary, prudent investors consider them when evaluating investments, but they don’t let the two factors drive the decision. We’ve written before about chasing crowds and jumping on trends and the dangers of both (You can read about it here and here) and this is an extension of those warnings.  

Institutional investors can be a good place to look for insights. When making decisions about what investment moves to make, they will “price in” how they believe the economy will affect the price of a stock. If you keep an eye on what they are doing, you will see that market trends are often a foreshadowing of economic trends. But, because economic and market movements are not correlated, all your investments should begin with value at the core.  

Importance of Value  

When you buy value, you are investing in a vehicle that is financially sound. As with diversification, value reduces the volatility of your portfolio by introducing investments that have an historical track record of stability. Although value investments can lose money, losses will be tempered by the strength of the investments because they are not as prone to the ups and downs of business as higher risk investments.  

Determining the value of an investment varies depending on the type of investment. If you are considering the stock of an individual company, there are a variety of business metrics you can use such as price to earning ration. Investopedia created a list of some of the most popular.  

Mutual funds also come in varying degrees of value, just as individual stocks, and Investopedia has another list to consider when you are evaluating investment options. Here what they have to say in the section called “Selecting what Really Matters”: 

Morningstar has since introduced a new grading system. With the new rating system, the company looks at the fund’s investment strategy, the longevity of its managers, expense ratios, and other relevant factors. 

The number of factors required to conduct a thorough evaluation are many, so take the time you need to identify the best value for your investment dollars.  

Conclusion 

While economic trends can have a dramatic effect on movement in the stock market, they do not move in perfect correlation. Very often, as 2021 illustrates, they will move in opposite directions. And because no one can predict the future, although many have tried, it is important to look first to the value of the investments you are considering.  

Ignoring the value while following trends will end badly for you and your portfolio.