How often do you see someone on the road driving completely recklessly? Weaving in and out of traffic, going way too fast, slamming on the breaks – all to save a few minutes on their commute. A) he or she is risking their safety and the safety of others, and B) that kind of driving is more likely to capture the eye of a police officer.
Keeping a prudent plan can be a good thing when it comes to driving and investing. You may hear your colleagues trading the latest hot stock, and how much of a killing they made. Then you start to feel the urge to roll the dice too. There are many behavioral traps we can fall victim to – that is why a plan is required in addition to just keeping risk in check.
In the end, an investment plan is much more about managing risks than it is about scoring a huge win in the stock market. The investment process begins by writing down your risk and return objectives, then forming a portfolio tailored to your circumstances. As life changes, your ability and willingness to take on risk will change. It is our job at TFC to work with you to update your investment policy statement and then make the necessary tweaks to your portfolio.
Risk comes in many forms – of course, there is risk in the stock market, but there is also a risk in the bond market believe it or not. Most investors think they can’t lose money investing in U.S. treasury bonds – but you can lose your shirt! How can that be? Inflation.
An investment in bonds back in 1940 would not have been profitable, after inflation and including interest, until 1991! Treasury bills with a shorter maturity had a negative return after inflation from 1933 to 2001. So what may seem safe in the short-run can be incredibly risky in the long run; it’s not just about playing it super-safe all the time. “Safe” can be risky.
Ok, we get it. It’s good to have the risk portfolio allocation based on one’s risk and return objectives. But what about the return objective? How do we determine that? What should an investor expect to receive going forward? Let’s take a look at stocks and bonds.
For stocks, the historical global equity market portfolio has earned a return, after inflation, of 4.5-5% per year. The U.S. market has done very well versus the rest of the world across virtually all timeframes, so don’t get sucked into the expectation that 10% returns are the norm. The U.S. is now a mature economy with much slower population growth versus the early and middle 20th century, so future returns may be weaker.
In the fixed-income world, current interest rates are the biggest driver for future returns. And we all know how low yields and savings account rates are nowadays. Harken back to the early 80s when you could earn 10% or more on a bond! No longer the case. As of mid-2020, the 30-year Treasury bond yield is near 1.3% – below inflation!
Most fixed-income investors have a reasonable portion of their portfolio in the ‘aggregate bond index’, and the rate on that investment is just 1.65%. Paltry yields in the bond world make it tough for an investor who just can’t accept the risk in the stock market. Beware of the behavioral trap of taking on a more-risky portfolio in an attempt to capture a little more return. Often, bond investors will venture into the stock market hoping for higher returns – but that dramatically changes a portfolio’s risk profile.
A prevalent risk in today’s investing world is investing too much in your employer’s stock. This is another bias – we feel like we know the company for whom we work. Also, there may be a sense of loyalty we find when holding on to that stock. Finally, if everyone at the water cooler is talking about how well their nest-egg is doing, all-in on the company stock, it can be tough to stray from the herd. But just remember what happened with the Enron scandal! It is risky to have both your retirement (your financial capital) and your career (your human capital) invested in the same thing. So spread the love a little bit, and diversify.
Here’s the point
- Risk versus return is difficult to pin down. It is different for each investor and changes over time for everyone.
- TFC is focused on risk management and ensuring each client has the proper risk and return objective set forth in their investment policy statement.
- Returns going forward are likely to be weaker than in the past – both in the stock market and in bonds.
- Avoid parking too much of your money in your employer’s stock.
Action items
- Stay the course. TFC takes each client through an extensive risk assessment process. If you feel the need to discuss where you stand, you are welcome to do so.
- Save more, don’t stretch for higher returns. In the end, your personal savings rate matters more than getting a little more return in the markets.
- Be confident. Know that together we have developed the right investment plan tailored to your situation.
Photo by Derek Thomson on Unsplash