The Temptation to De-Risk

Contributed by Doug Walters , Max Berkovich , ,

Stocks put in a positive performance this week, up over 2%, and are now solidly in the green for the year. This performance comes despite no deal on the next stimulus bill and still a wide gap between the House, which has proposed bringing down the size of their bill from $3.4T to $2.4T and the White House, which says it cannot go far above $1T. Expectations are for a $1.5T compromise, but the path to that number is still very unclear.

With uncertainty in the air, and the stock market approaching all-time highs, we are increasingly fielding questions from clients wanting to “de-risk.” There are two types of de-risking; one is sound financial planning, and the other is gambling. The first has to do with an investor’s changing circumstances. For example, an investor who inherits $1,000,000 may find that they either no longer need to take as much risk, or that they now have an ability to take on a lot more risk. The second is the investor whose circumstances have not changed but thinks the market is “getting expensive” or “has run too much” or that we are “due for a pullback” and wants to take some risk off the table. This is market timing and a dangerous gamble for long-term investors (see our whitepaper on the subject).

So are we saying the market will not fall? No. We cannot predict the future and do not base our investment decisions on the unknown. Rather, we take an evidence-based approach to managing portfolios, and the evidence says to avoid market timing. If you are still concerned here are some facts to consider:

• Stocks go up a lot more than they go down, so on average, exiting the market is going to be the wrong decision for long-term investors (and don’t forget, even if you are right on the way out you also have to correctly predict when to get back in).
• Sitting on the sidelines and missing just a few big market days can be devastating to long-term returns. As our whitepaper shows, missing just ten days over 20 years could cut your annual return in half. Do you want to be out of the market the day that a successful vaccine is announced?
• The recent rally has been heavily driven by the strong performance of “The Big Five” (Apple, Amazon, Alphabet, Microsoft, and Facebook). These are some of the largest companies that are currently driving the market. However, when a vaccine allows the economy to normalize, the cyclical, industrial, and retail companies could lead the next leg of the rally.

These are times that try the nerves of investors, and at some point, the market will pull back again, maybe in this crisis or perhaps the next. But trying to predict the ups and downs has never been a good investing policy. We recommend well-diversified portfolios, at a level of risk appropriate for the investor, and would avoid a pure market-cap-weighted approach to ensure you do not get caught out if The Big Five pull back.