Buy Or Sell? A Question Of Risk Management

Whether you ride this bull market or stay on the sidelines is not a matter of brilliance, but of risk management. To illustrate, we look at lessons to be learned from the “greatest predictor” of market returns (hint: it isn’t).

Nobody knows whether the market is going to plunge next year, but anyone who fears that it might be well served taking that into account, as staying fully invested presumably implies taking on more risk than one is comfortable with.

That said, the investment industry is geared towards talking you out of that fear; after all, markets “always go up in the long run”, don’t they? Truth be told, none of us has a crystal ball. I get particularly concerned when a strategist says: “The markets may not be cheap, but expect a 10% return next year.” In my experience, he or she might as well say: “we have no clue, but if we tell you the markets might go up 10%, we can continue selling you investment products.”

Getting educated about the risk factors affecting one’s portfolio helps one manage that fear and make more rational judgments about it. But make no mistake about it: losing 20, 30 or 50% of one’s portfolio is not something every investor can or wants to stomach, even if it is possible to recover from a loss “if one stays the course.”

While conventional wisdom suggests stocks go up in the long-run, it makes a big difference whether you invest in March 2000, the peak of the dot-com bubble; or March of 2009, the financial crisis low for major equity indices. With a ten-year horizon, odds are the market will experience both euphoria and panic. If you invested in the S&P 500 on March 9, 2000, you would be in the red 10 years later, even if you reinvested dividends. Conversely, if you invested ten years ago, in November 2007, an investment in the S&P 500 would have had a decent return; ask yourself, though, whether you would have stayed the course throughout the financial crisis. Finally, if you invested at the post-crisis low in March 2009, your ten years aren’t over, but you could brag of double-digit annualized returns through Thanksgiving this year:

The short of it: if you were concerned about valuations in March 2000, your fears were warranted, even if someone tells you, don’t worry, in the long-run, you’ll be just fine. Incidentally, if you look at the advertising of some advisors, they boast of their “long-term” track record post-2008. In the opinion of yours truly, and as I believe this little exercise illustrates, you should take any such boasting with a grain of salt.