Has the market peaked out? Are we due for another decline?
These are the types of questions our advisors are asked often. Although market conditions can change dramatically from year to year, the answers to these questions, we feel, are reliably consistent.
It may not surprise you to hear that the media’s portrayal of the financial world does not always go hand-in-hand with the actual state of the market. Media, to a great extent, is there to grab the attention of the viewer anyway it can. To do this, the media must produce fresh dramatic content that doesn’t always put forth, shall we say, a well-balanced point of view. Throughout history, markets have risen and fallen and this will continue to be the case. And while the experience of a short term decline in the market doesn’t feel good at the time, over any considerable period, it’s impossible to predict when a rebound will take place. How many media experts predicted a better-than 100% rebound (to date) from the low point in 2009, yet that is where we sit today?
Are Financial Media and Investment Professionals Focusing on the Negative?
Historically, the overall market has experienced growth about 80% of the time. But do we hear that much good news coming from our financial media sources? To the contrary, the vast majority of what is being reported is negative and it’s the sheer volume of the negativity that can lead some investors to question when it’s ever a good time to participate in the market.
That brings up the idea about how the media can influence the market. Yes, financial news as reported by the media can affect markets in the short run, but over a longer period of time it will always be the financial performance of companies and evaluations by market participants that determines stock market prices. The reason for this is because as a company grows and become more successful, more investors are willing to pay for their stock and will purchase it from investors who are pessimistic or want to reduce their market exposure. That is why we say that the market is very forward-looking. It is structured in a way that is anticipating what’s to come, not necessarily what has occurred. It is based on investor expectations including optimism, pessimism or uncertainty. Once again we must caution against looking at short-term trends as a way to influence our long-term investment goals.
At Premier, we are strong advocates for pursuing an investment strategy based on discipline and consistency. Our experience has shown time and time again, that our approach to investing has worked in fair weather and foul. We invite you to meet with us so we can understand your investment goals and share how our solution may be a fit for you.
The Various Types of Investment Risks
There are many different types of investment risks including business risk, financial risk, interest rate risk, purchasing power risk, concentration risk, reinvestment rate risk, exchange rate risk, country risk, and market risk. Two of the most important types of risk that we pay close attention to are unsystematic risk and systematic risk. Unsystematic risk is the diversifiable portion of total risk. It can be eliminated by increasing the number of securities in a portfolio which is exactly what Premier does to manage this type of risk in client portfolios. A poorly diversified portfolio fails to eliminate a significant amount of its unique (or concentrated) risk, while a well-diversified portfolio would have little, if any, unique risk left. Since investors can eliminate unsystematic risk by increasing the number of securities in their portfolios, they are not rewarded for bearing this risk. Unsystematic risk is therefore uncompensated and should be avoided.
Systematic risk is the non-diversifiable component of total risk. It represents the variability in all risk exposed assets attributed to macroeconomic variables. A market portfolio, by definition, consists of all risk exposed assets traded in the global marketplace. Macro-economic forces prevailing in the market drive the systematic risk of any investment. This could include changes in the growth rate of the Gross National Product, inflation, interest rates and the money supply. The extent to which the performance of an investment is affected by a shift in these fundamental economic forces may be different, but there is no way for any investment to escape from the impact. The fact that investors cannot diversify away systematic risk by increasing the number of securities in a portfolio makes systematic risk the only risk that investors should be rewarded for.
How to Reduce Your Investment Risk
For more than 17 years, Premier Financial Group has been utilizing structured asset class portfolios to help clients to eliminate unsystematic risk. By having a broad cross section of industries and companies represented in the portfolio, the overall investment risk is reduced. We focus on including components of the market that result in compensated risk such as value oriented stocks, small company stocks, and the stock of established companies in emerging economies.
To offset the systematic risk (the risk that cannot be eliminated with regards to investments) we work with clients to balance their risky assets with conservative high-quality, short-term fixed investments. This helps to reduce the overall volatility in client portfolios. We advise clients to maintain a comfortable cash reserve as well as a fixed component, especially if they are withdrawing from their portfolio systematically, to get them through difficult market periods. Over the past 25 years, we have found that our biggest risk with client portfolios is not that their portfolio would become worthless, but that when the market declines in the short-term, it would be perceived as more risk than the client could bare and they would force us to liquidate, locking in losses. This can be unfortunate and costly to a long-term investment portfolio. If there is not a significant short-term need for the funds, it is generally best to stay the course and give the portfolio time to recover. The sell decision is often a choice rather than a need. Investors can choose to sell low or choose to sell high.