Plain Sight Strategy #2: Managing for Market Risks
In our last piece, we wrote of why most investors should ignore the never-ending onslaught of unpredictable financial news and tend to three strategies that can be much more readily managed – at least once you know they are there. Hidden in plain sight, these potent strategies include:
- Being there
- Managing for market risks
- Controlling costs
Plain-Sight Strategy #2: Managing for Market Risks
Don’t take on more risk than you must.
When it comes to investing, we need to acknowledge that the market would not provide us rewarding returns if it didn’t periodically punish us with realized risks. That is why it’s so challenging for most investors to “be there,” consistently capturing available returns by remaining invested over time. It’s also why it’s vital to avoid taking on more risk than we should in pursuit of our personal goals. For this, we have two powerful tools at our disposal, best used together.
Diversification: Eliminating Unnecessary Risk
Diversification helps spread the risks around. If you instead concentrate your portfolio in too few holdings, sectors or geographical locales, you may feel you’ve made smart selections when they’re doing well, but when bad news hits an undiversified portfolio, it often arrives without warning and with a vengeance. That’s a real risk that investors too often ignore at their own peril.
For example, sometimes, tech stocks are red hot; sometimes domestic securities may seem safer than international choices – or vice-versa. Your company’s stock or a popular IPO (Initial Public Offering) may seem like a sure thing. But by trying to position yourself to catch the next trend or dodge some bad news, you’re also subjecting yourself to the risk that your “sure thing” could fail.
Decades of academic inquiry has informed us that there are no extra returns expected by trying to consistently predict individual winners and impending losers. Instead, you are better off eliminating this form of risk by putting diversification to work for you.
Asset Allocation: Minimizing Unneeded Risk
While some risks can be diversified away, there are some that always remain. These risks are expected to enhance your long-term returns if you build them into your total portfolio, and if you stay the course with them over time. They include a handful of factors, that, over time, have proven their persistence:
- Equity – most stocks (equities) have historically returned more than bonds (fixed income).
- Size – most small-company stocks have historically returned more than large-company stocks.
- Value – most value companies (whose stocks appear to be either undervalued or more fairly valued by the market) have historically returned more than their growth company counterparts.
By blending a customized mix of riskier and less risky asset classes into your portfolio, you can seek to build toward your personal financial goals while fine-tuning the risks involved. In contrast, chasing returns you may or may not obtain can result in sacrificing what you’ve already accumulated if the risk is realized. Why even go there?
Diversification and Asset Allocation: A Potent One-Two Punch
Investment risks are most effectively managed by using the combined benefits of diversification and asset allocation. Many investors believe they are well-diversified when, quite often, they are not. They may own a large number of stocks or stock funds across several accounts. But, upon closer look, the bulk of their holdings may represent one or two concentrated factors, such as mostly large-company domestic stocks. They may think they are managing their risks through diversification but, by failing to implement appropriate asset allocation, excess risk remains.
Diversification helps to eliminate unnecessary risk – the kind that is not expected to improve your investment returns to begin with. Guided by your financial goals, asset allocation helps to diversify appropriately in an effort to minimize unneeded risk and to properly manage the market risks that are inherent when investing.
At Shore Point Advisors, we believe in owning nearly “the entire market” including allocations to international and emerging market equities. By expanding the number of asset classes and regions while reducing the concentration of single-name holdings and sectors, our goal is to reduce the excess risks that can be diversified away with the objective of pursuing higher expected returns. That’s our second plain-sight strategy of managing market risks.
In our final piece, we’ll introduce our third plain-sight strategy for investment success: controlling the costs involved.
Shore Point Advisors is registered as an investment adviser with the State of New Jersey. Shore Point Advisors only transacts business in states where it is properly registered, or is excluded or exempted from registration requirements. Past performance is not indicative of future results. All investment strategies have the potential for profit or loss. There are no assurances that an investor’s portfolio will match or outperform any particular benchmark. This content was prepared by a third-party provider. All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. All expressions of opinion reflect the judgment of the authors on the date of publication and are subject to change.