Are you managing your investment risk?
“The essence of investment management is the management of risks – not the management of returns. Well-managed portfolios start with this precept.” – Ben Graham
Last Friday, as we were blissfully cranking along to another nice up day, the Russians and Ukrainians were reported as shooting at one another again, causing the market to drop like a rock. We lost 150 points in short order before things settled down and we recovered most of that by the close. In spite of this downside flurry, we did end the week with all three of the major market indicators higher than the week before.
My point is not to belabor the geopolitical risks to our market – those will always be there in some manner and are definitely beyond our collective control. What I want to illustrate is that, when we’ve had such a run up as we’ve enjoyed in stocks these past few years, and with bond yields as low as they are, you’d do well to review your asset allocation strategy.
Strategy
For the record, my feeling that we’re in a long-term, secular bull market hasn’t changed yet. That doesn’t imply or mean rising straight up. There will be setbacks and corrections. I don’t have any particular ill long-term feelings about the markets right now. However, given what the stock and bond markets have been doing lately, it seems that it now would be prudent for you to do a risk assessment of your holdings.
As Mr. Graham suggests, this is a key to realizing your goals. By using an asset allocation strategy designed to help you achieve your goals when you want to with the least amount of risk needed to do so, you can keep on toward your goals, no matter the short-term situation.
Once you have set up the allocation, in order to help keep it tracking as you wish, a regular review of how the pieces of your overall strategy are doing is a really good idea. At Opus, for example, we do this twice a year for our clients. Simply stated, if you have sectors that have gains, as you do your review, consider taking the amount of those gains and transferring them into those parts that are lagging. By selling high and buying low, you can have a positive effect on your long-term results.
If you’d like a second opinion on your asset allocation strategy or want to set one up, please contact me for a no obligation meeting to discuss it.
Why now?
When things are running up, it’s easy to get caught up in the momentum and assume that they will keep doing so. (The opposite is also true…) So far this year, you’ve seen your bond funds and bond prices holding, if not appreciating somewhat, as interest rates have continued to slide. Stock prices have also done well over the past couple years. Let’s look at what’s going on away from the headlines that may affect both situations.
The 10 year US Treasury note closed at its lowest yield in over a year on Friday. Not sure what motivates someone to tie up their money for 10 years at what is, currently, about the same rate as inflation. After tax, that would provide them a negative real return. The flight to safety from overseas is a contributor to the low yields, for sure, with lots of funds chasing a fixed supply. Seems that many folks are concerned about the level of stock prices so they put their money where their principal is safe – even if they’re really losing money. In other words, seems the main reason for interest rates being so dang low is that people and corporations continue to stay away from risk.
Consider that in 2007, a typical three month CD was offering a better return than do junk bonds today. And, average yields on investment-grade debt worldwide dropped to a record low 2.45 percent from 3.4 percent a year ago, according to Bank of America Merrill Lynch’s Global Corporate Index. Doesn’t seem to me that bond investors, particularly in corporates, are getting paid anything close to their relative risk.
Watch the curve
The curve I’m referring to is the yield curve. Simply, that shows how interest rates plot out over time. The premise is that the longer you invest in a fixed-income investment of whatever type, the more you should receive in payment (interest) for the risk you’re taking. Most talk is focused on the 10 year US Treasury as it’s the main reference point for US interest rates and many loans. I suggest that it’s not a bad thought to keep an eye on the relationship between what the 10 year is paying, compared with the 30 year bond. The difference, known as the spread, has remained around one percent.
If we see this spread widening fairly quickly, it would likely mean that higher rates are on the way with definite negative effects on bonds – as well as most other primarily yield-oriented issues like utilities, telecom stocks and some MLPs and REITS. A portfolio made up of these kinds of issues would be subject to significant volatility and, probably, downside risk.
Summary
Capital preservation is a very good thing. So is the growth of that capital. Having the best of both worlds is, to me, a definite benefit of a well-constructed asset allocation strategy. It allows you to disregard the noise coming from the short-term markets, while keeping you focused on your goals.
It seems fairly clear to me that, even after the market’s summer doldrums where we have more than 14 people participating on the NYSE trading floor, we’re moving from a period of simply buy and hold complacency has been working. At some not altogether far time, we know that the Fed will raise rates. How well you manage your overall portfolio risk is going to be significant.
It’s my experience that your long-term investment success is not just from floating up with the rising tide of market moves but, more importantly, avoiding those major losses that can take time to recover from.
Start your review today!
Cheers!
Mike
509-747-3323
Securities and Investment Advisory Services offered through KMS Financial Services, Inc.
To get an overview of economic conditions, use this link. It’s updated monthly. http://www.russell.com/Helping-Advisors/Markets/EconomicIndicatorsDashboard.aspx
Past performance is not indicative of future returns.
Investing in securities of any type involves certain risks, including potential loss of principal. Investment return and principal value in a bond and/or securities portfolio will fluctuate so that investments, when sold or redeemed, may be worth more, or less, than the original investment.
Investing in sectors may involve a greater degree of risk than investments with broader diversification. International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets. Investing in emerging markets can accentuate these risks.
