What Gives You Control?

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Which of the following do you have more control over?

  1. Timing the market’s ups and downs
  1. Staying Invested and Staying Disciplined

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You missed 1 day out of over 11,000, so what?

Above is a graphic that shows how reacting to market conditions (and/or attempting to time the market’s ups and downs) would change your return as an investor.  This example uses the Performance in the S&P 500 between 1970-2015 (that’s over 11,000 market days).  The annualized compound  return for the entire period was 10.27%.  If you had missed the single best day in the market during that time, your annualized compound return would be 10.01%.  In dollar terms, if you had invested $1,000 at the beginning of the period and received 10.27% annual return, you would end with $89,678.  If you had missed the best single day you would have missed out on $9,308 because your end result would be $80,370.  As a long term investor, that is quite severe a penalty for missing one day –  out of 46 years.

Let’s go a step further and say you missed the best 25 days.  Your annualized compound return would be 6.87%; or $21,224  if you had invested $1,000 at the beginning of the period.  That is a difference of $68,454 because you missed 25 days out of over 11,000.

If You Are an Investor, Then Be an Investor.

As investors, we want to focus on things that we can control.  What is out of your control? Predicting the market’s ups and downs, and letting our emotions determine the timing or frequency of our investments.  What is in your control? Settling on an appropriate mix of investments, investing in them, and staying true to your original objectives – knowing that there will be ups and downs along the way.

 

So instead of answering our original question, we’ll let you be the judge!

 

 

 

Attribution and Disclaimer: Graphic in US dollars. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Performance data for January 1970–August 2008 provided by CRSP; performance data for September 2008–December 2015 provided by Bloomberg. S&P data provided by Standard & Poor’s Index Services Group. US bonds and bills data © Stocks, Bonds, Bills, and Inflation Yearbook™, Ibbotson Associates, Chicago (annually updated work by Roger G. Ibbotson and Rex A. Sinquefield).

 

Woodstone Financial, LLC is a fee-only financial planning and investment management firm located in Asheville, North Carolina.   Contact us to learn more about our services.

Managing The Market’s Risky Business

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What is a simple, one word answer to the Question: How can we manage investment risks?

 

The Answer: Diversification

 

There’s Risk, and Then There’s Risk

Before we even have words to describe it, most of us learn about life’s general risks when we tumble into the coffee table or reach for that pretty cat’s tail. Investment risks aren’t as straightforward. Here, it’s important to know that there are two, broadly different kinds of risks: avoidable, concentrated risks and unavoidable market risks.

 

  • Avoidable Concentrated Risks

Concentrated risks are the ones that wreak targeted havoc on particular stocks, bonds or sectors. Even in a bull market, one company can experience an industrial accident, causing its stock to plummet. A municipality can default on a bond even when the wider economy is thriving. A natural disaster can strike an industry or region while the rest of the world thrives.

 

In the science of investing, concentrated risks are considered avoidable. Bad luck still happens, but you can dramatically minimize its impact on your investments by diversifying your holdings widely and globally, as we described in our last post. When you are well diversified, if some of your holdings are affected by a concentrated risk, you are much better positioned to offset the damage done with plenty of other, unaffected holdings.

 

 

 

 

 

 

 

 

 

 

 

  •  Unavoidable Market Risks

If concentrated risks are like bolts of lightning, market risks are encompassing downpours in which everyone gets wet. They are the persistent risks that apply to large swaths of the market. At their highest level, market risks are those you face by investing in capital markets in any way, shape or form. If you stuff your cash in a safety deposit box, it will still be there the next time you visit it. (It may be worth less due to inflation, but that’s a different risk, for discussion on a different day.) Invest in the market and, presto, you’re exposed to market risk.

 

Risks and Expected Rewards

Hearkening back to our past conversations on group intelligence, the market as a whole knows the differences between avoidable and unavoidable investment risks. Heeding this wisdom guides us in how to manage our own investing with a sensible, evidence-based approach.

 

Managing concentrated risks – If you try to beat the market by chasing particular stocks or sectors, you are exposing yourself to higher concentrated risks that could have been avoided with diversification. As such, you cannot expect to be consistently rewarded with premium returns for taking on concentrated risks.

 

Managing market risks – Every investor faces market risks that cannot be “diversified away.” Those who stay invested when market risks are on the rise can expect to eventually be compensated for their steely resolve with higher returns. But they also face higher odds that results may deviate from expectations, especially in the near-term. That’s why you want to take on as much, but no more market risk than is personally necessary. Diversification becomes a “dial” for reflecting the right volume of market-risk exposure for your individual goals.

 

Your Take-Home

Whether we’re talking about concentrated or market risks, diversification plays a key role. Diversification is vital for avoiding concentrated risks. In managing market risks, it helps you adjust your desired risk exposure to reflect your own purposes. It also helps minimize the total risk you must accept as you seek to maximize expected returns.

 

This sets us up well for our next piece, in which we address another powerful benefit of diversification: smoothing out the ride along the way.

 

 

Woodstone Financial, LLC is a fee-only financial planning and investment management firm located in Asheville, North Carolina.   Contact us to learn more about our services.