The last few days provided a not so subtle reminder that there is real risk investing in stocks. However, the true risk lies in how you react to the pit that formed in your stomach as global markets dropped.
You see, that pit is our body’s biological response to fear. We are wired to seek safety when we feel threatened. As abruptly as global markets dropped the last few days, it is normal to feel threatened.
While that reaction saves us in many aspects of life, it is one if the primary causes of the Behavior Gap we talk about so frequently, and that we are seeking to avoid with our investment philosophy. The proper response to these movements is already set in writing within the pages of your Investment Policy Statement.
The other common cause is a desire for greater returns than your risk profile can handle. Over the last 6-12 months, many of you have asked about increasing your exposure to stocks given their excellent performance the prior 5 years and the agonizingly low interest rates on bonds in today’s environment. Let the last few weeks be exhibit A for why we stand firm and resist those calls to change the risk composition of the portfolio, in good times and in bad. You can’t buy last year’s returns.
In reality, markets drops like this are more common than most people realize. While these drops generally do not occur over the course of a couple days, they happen quite regularly. We have not experienced a drop off this magnitude since 2011, so we start to think this is rare. In reality, we were overdue.
The market needs an occasional shock. It is healthy. In recent years, the amount of leverage in the market has grown significantly as traders have ignored the lessons from 2008. Shocks like this help flush out that leverage and bring it back down to more reasonable levels. They also remind investors there is risk in investing, and managing the risk level of your portfolio is far more important than picking the perfect investments or beating / matching the returns of an arbitrary index, whether that is the S&P 500 or the Dow.
Today, the underlying economic situation is significantly better than 2008. And remember that your portfolio is built with the most academically sound principles available. It is designed not only to survive these shocks, but to thrive as we emerge on the other side if them.
We are in the process of rebalancing portfolios that have seen its stock allocation drop outside of our targets. However, in the midst of this drop, many portfolios have not even deviated enough to warrant a rebalance. We will keep you posted as it happens.