Market Volatility Can Serve as a Reminder of an Investor’s True Risk Tolerance10-30-2018 |
Sources: Sources for data in tables: Equity Market and Fixed Income returns are from JP Morgan as of 10/26/18. Rates and Economic Calendar Data from Bloomberg as of 10/29/18. International developed markets measured by the MSCI EAFE Index, emerging markets measured by the MSCI EM Index. Sector performance is measured using GICS methodology.
As global equity markets continue their month long retreat, many investors may be questioning if it’s time to swap their stock portfolio for cash in an attempt to avoid further downside. In our view, this rationale is often misguided and shortsighted. It also generally indicates that those investors expressing such sentiment do not have a longer term plan in place and may not have been realistic about their own comfort level with market risk. Let’s first start with an update on global capital markets before diving into why it’s advantageous to build a portfolio that closely mirrors one’s tolerance for risk, and how doing so can potentially avoid that uneasy feeling that a steep sell-off produces.
In the U.S., the S&P 500 Index retreated 3.93%, settling at a level of 2659, while the Russell Midcap Index lost 4.35% for the week. The Russell 2000 Index, a measure of the Nation’s smallest publicly traded firms, followed the lead of its larger counterparts, dropping 3.76%. On the international equities front, developed markets mimicked their U.S. counterparts with a decline of 3.87%, while emerging market equities lost 3.27%. Finally, the 10 year U.S. Treasury yield abated to a level of 3.08% as global investors flocked to the perceived shelter of U.S. Treasuries.
As previously mentioned, a longer term investment portfolio should be structured based on an individual’s risk tolerance and investment objectives, and not necessarily swayed by one’s sentiment toward capital markets at any given point in time. Pursuing a strategy based on the latter will almost undoubtedly lead to actions that will produce adverse consequences over time. For instance, consider a fairly conservative investor that’s overly exposed to more volatile assets, such as stocks. This investor likely understands that their overall investment mix doesn’t adequately represent their true risk tolerance, but finds solace in their misguided assumption that their ability to exit the market before a major sell-off will be perfectly timed. Unfortunately, this viewpoint overlooks that they must have perfect timing twice (entering and exiting), and if their timing isn’t flawless, they may miss out on the strongest returns a given market cycle has to offer. In fact, the 10 best performing days have occurred within two weeks of the 10 worst performing days over the past 20 years.
If said investor had realistically accessed their tolerance for risk by evaluating a few key factors, such as their time horizon, tax consequences, and liquidity needs, they likely would have recognized that their tolerance for risk was in fact low, indicating that the portfolio required a heavier tilt towards less volatile assets, which would have produced less variability in the portfolios overall value. When a portfolio is properly diversified and built to an individual’s unique risk tolerance, fluctuations in value become more tolerable and there is less of an inclination to try and “time the market “.
While it may be impossible for investors to avoid risk entirely, they can help protect themselves from the unexpected by building a balanced and diversified portfolio and having a longer term financial plan in place. As a result, we encourage investors to revisit the diversification that may, or may not, be in place within their existing portfolios and update (or complete) their financial plans as appropriate. If you would like to learn more about how we are helping clients invest dynamically and consistently with their own goals, timeframe and tolerance for risk, please do not hesitate to speak with your Hennion & Walsh Financial Adviser.
Disclosures: Past performance does not guarantee future results. We have taken this information from sources that we believe to be reliable and accurate. Hennion & Walsh cannot guarantee the accuracy of said information and cannot be held liable. This information is provided for informational purposes only and is not a solicitation to buy or sell any of the asset classes or sectors discussed.
Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility. These risks are heightened in emerging markets.
There are special risks associated with an investment in real estate, including credit risk, interest rate fluctuations and the impact of varied economic conditions. Distributions from REIT investments are taxed at the owner’s tax bracket.
The prices of small company and mid cap stocks are generally more volatile than large company stocks. They often involve higher risks because smaller companies may lack the management expertise, financial resources, product diversification and competitive strengths to endure adverse economic conditions.
Investing in commodities is not suitable for all investors. Exposure to the commodities markets may subject an investment to greater share price volatility than an investment in traditional equity or debt securities. Investments in commodities may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity.
Products that invest in commodities may employ more complex strategies which may expose investors to additional risks.
Investing in fixed income securities involves certain risks such as market risk if sold prior to maturity and credit risk especially if investing in high yield bonds, which have lower ratings and are subject to greater volatility. All fixed income investments may be worth less than original cost upon redemption or maturity. Bond Prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline of the value of your investment.
MSCI- EAFE: The Morgan Stanley Capital International Europe, Australasia and Far East Index, a free float-adjusted market capitalization index that is designed to measure developed-market equity performance, excluding the United States and Canada.
MSCI-Emerging Markets: The Morgan Stanley Capital International Emerging Market Index, is a free float-adjusted market capitalization index that is designed to measure the performance of global emerging markets of about 25 emerging economies.
Russell 3000: The Russell 3000 measures the performance of the 3000 largest US companies based on total market capitalization and represents about 98% of the investible US Equity market.
ML BOFA US Corp Mstr [Merill Lynch US Corporate Master]: The Merrill Lynch Corporate Master Market Index is a statistical composite tracking the performance of the entire US corporate bond market over time.
ML Muni Master [Merill Lynch US Corporate Master]: The Merrill Lynch Municipal Bond Master Index is a broad measure of the municipal fixed income market.
Investors cannot directly purchase any index.
LIBOR, London Interbank Offered Rate, is the rate of interest at which banks offer to lend money to one another in the wholesale money markets in London.
The Dow Jones Industrial Average is an unweighted index of 30 “blue-chip” industrial U.S. stocks.
The S&P Midcap 400 Index is a capitalization-weighted index measuring the performance of the mid-range sector of the U.S. stock market, and represents approximately 7% of the total market value of U.S. equities. Companies in the Index fall between S&P 500 Index and the S&P SmallCap 600 Index in size: between $1-4 billion.
DJ Equity REIT Index represents all publicly traded real estate investment trusts in the Dow Jones U.S. stock universe classified as Equity REITs according to the S&P Dow Jones Indices REIT Industry Classification Hierarchy. These companies are REITs that primarily own and operate income-producing real estate.