As the CEO of a wealth management firm for high net worth individuals and ultra-high net worth families, I’m often asked by clients what they should do about their investments. I have seen firsthand instances of clients wanting to do things based purely on emotion, and because investors are human, greed and fear can often come into play. While emotions are sometimes well founded, an investor can wind up as their own worst enemy.
Investors may lack the discipline to capture the returns that the investment markets can provide over a longer period by making short-term-focused decisions. When the markets are going great, investors can often become more aggressive and add more market-correlated assets. And of course, when the markets tank (like in 2008), a typical investor can become extremely conservative, usually at the worst moment.
According to Dalbar data, poor timing caused the average investor to lose twice as much as the S&P 500 in 2018. What that means is many investors are chasing performance and investing after a period of strong performance and selling after a period of poor performance. Buying high and selling low — that’s exactly the opposite of what investors strive to do.
So, what should investors do now with the market at new highs and recognizing that they may want to do something not necessarily in their best interest? Based on these emotions, they will probably want to add to their equity investments. Instead, they should first consider the probabilities of the markets continuing to rise as well as the probabilities of a market pullback. Because there is always uncertainty, there are investment strategies that can work well in either scenario.
One such example we developed provides clients with participation in an upward-moving stock market while also offering significant downside protection to buffer against potential losses. Given the strategy’s defensive stance, it can be expected to underperform the equity markets as they rise and is better suited to times of market uncertainty, but can still be profitable in rising markets.
Obviously, stock markets could continue their upward march; however, I believe having some protection makes sense at these levels. Going back to the fact that investors are human and will act based on emotions, I like to say that one of our most important jobs as professional investors is to protect clients from themselves. That is why it is so important to utilize strategies to help dissuade investors from wanting to do things that might not align with their goals or situation. I believe all qualified investors should consider utilizing strategies such as the one above along with other noncorrelated strategies such as secured asset-backed lending (short-term bridge loans secured by real estate) and direct real estate investments. Of course, traditional stocks and bonds also help reduce the average daily volatility of portfolios. I believe employing such strategies improves the odds that investors will “stay the course.”
An advisor’s job is to explain to an investor that it may be better to focus on the longer term and more fully understand what their real risk tolerance might be. Investors might say “3 out of 5” on their own risk scale, but do they really understand what that means in actual dollars during a punishing market period? One way an investor can determine their real risk tolerance is by exploring potential scenarios with their advisor, who can help them determine what, based on thousands of data points, a loss to their existing portfolio might look like. When a person sees in black and white the actual dollar amount of potential losses, it becomes a true litmus test of their willingness to tolerate short-term portfolio losses often part and parcel to long-term successful strategies. Of course, the goal should always be to achieve the highest return while seeking to minimize risk and volatility.
Focusing on rosy projections can do an investor a disservice by not fully exploring risk and what happens when the markets don’t cooperate. Rather, an investor should consider both good and bad scenarios to fully understand what they think about risk. This is a realistic approach — one you should use when performing a self-examination of your own portfolio. And if you are one of those investors who seems to always be chasing the latest idea only to invest just as that idea flames out, I recommend you seek out an advisor who can provide you with strategies that reduce portfolio volatility and, hopefully, will be more likely to keep you on the path to long-term financial success. Good luck out there.
