Risky Behavior

“Volatility.”

If you’ve been following the markets over the past several months, you’ve likely seen and heard a lot about it, and you may have heard your advisor talk about it in the past. The coronavirus pandemic has spread across the globe, and with it has come volatility to markets not seen since the height of the Global Financial Crisis over a decade ago – and it’s times like these when having a firm grasp of its nature is crucial.

Volatility describes the inherent riskiness of an investment over a specific time horizon.  In the investment world we describe this as its “standard deviation.” In a nutshell, standard deviation describes the degree to which individual measures in a set of data vary from the average of that data set. Put more simply, it describes how dramatically asset prices depart from their longer-run averages.

Still a little fuzzy? Let’s have a look:

This is a simple sketch of two return paths. You can see they both end up in the same place, However, one had a much less “volatile” time getting there.

If they end up in the same place at the end, what’s the big deal?

The answer is that, for just about all individual investors, beating the market is functionally impossible. And sadly, most investors tend to lag markets badly over just about every time period. In fact, it’s during periods such as this one that truly awful investment decisions are made.

During the long bull market, we heard clients and prospective clients asking for “more risk” in their investment portfolios when what they really wanted was more return. In most cases, they did not fully appreciate that the risk they would be taking on was not a one-way escalator leading only up. They failed to envision the potential problems that spring up in markets that are impossible to predict (did anyone have “pandemic” on their short list six months ago?). Further, the temptation to sell is inevitably the highest as markets hit their low points.

You may think of your advisor’s role primarily as managing your money. This of course is true. The majority of your advisor’s time is likely spent making investment decisions, rebalancing your portfolio, and ensuring an optimal withdrawal strategy, as examples. With that being said, according to a 2019 analysis by Vanguard approximately half of an advisor’s value comes from managing psychology – in good times and bad.

Good advisors spend a great deal of time and effort learning about their clients’ beliefs and attitudes toward money and risk. From this, they can develop informed impressions of how those clients will react in extreme environments and prepare them both financially and emotionally for this possibility.

We believe that the best portfolio is the one you can stick with. If a strategy is going to be discarded in the bad times, it shouldn’t be pursued at all.

The next time you interview an advisor, or speak with yours ask about his or her attitude about risk, and how they perceive yours – it can be immensely informative.