Current market environment performance of dynamic, risk-managed investment solutions.
By Jerry Wagner
Risk management is a normal part of daily life—at home, on the road, and in our financial decisions.
At home, the pantry may be stocked with canned food and bottled water. Households with young children often have outlet covers and cabinet latches. A newborn may mean monitors and alarms. An elderly family member may require extra precautions, such as bathroom supports, bed rails, and a medical alert device.
Just in case.
On the road, we buckle our seat belts and rely on safety features like airbags. The roads themselves are designed with markings, safety engineering, and guardrails in the riskiest stretches.
In our financial lives, many of us rely on professionals and proven tools. We use accountants or expert-prepared software to file our taxes. When buying or selling a home, we often turn to a real estate agent—or at least review online tools to get an idea of value.
There are at least three elements common to all of the examples:
Yet when it comes to investing, these same principles are sometimes overlooked. It often takes increased market volatility to remind investors that uncertainty is always present—and to renew their focus on risk management.
Do your investments qualify for the same kind of “just in case” risk management that applies to much of everyday life? Let’s look at the three elements.
1. Is the risk real?
Since 2008, the S&P 500 has experienced numerous market pullbacks—some relatively modest, others more severe. Many of the smaller declines, often described as “baby bear” markets, were eventually followed by a resumption of the broader uptrend.
There have also been a few “grizzly bear” markets (declines of at least 20%), which can result in losses that take years to recover.
The danger is real.
2. Multiple types of protection
Mitigating investment risk has usually required more than a single approach. Many investors choose to track the domestic stock market through their portfolios, often using passive index funds that mirror broad benchmarks like the S&P 500 or the NASDAQ 100. These indexes contain many stocks, which helps diversify the risk of investing in any one company, where losses can be total. But just as index funds participate fully in market gains, they also participate fully in market declines.
Most investors who work with financial advisers diversify a second way: by investing across different asset classes. Yet major market corrections have shown the limits of this approach. When U.S. stock indexes decline, many asset classes that are expected to provide diversification have also fallen, sometimes by as much or more.
Historically, bonds, gold, and other commodities have offered the most reliable diversification. Still, as markets advance, the temptation to increase equity exposure grows. Investors adjust their answers to suitability profiling questionnaires to take on more risk. They neglect rebalancing and allow stock allocations to rise. They watch indexes climb while diversified portfolios lag, and they ask their advisers to take on more risk.
When the inevitable bear market arrives, they learn what risk really is. They suffer losses closely approaching those of the indexes they were trying to catch just months earlier.
The true “just in case” investor relies on more than index exposure and asset-class diversification alone. They build portfolios using multiple risk-management approaches, including employing dynamic, risk-managed strategies and diversifying not only by asset class but also by investment strategy. Their portfolios include “plan B” investments designed to provide redundant layers of risk protection.
Like insurance, these protections come at a cost. “Just in case” investors understand that you can’t have one foot out the door and do as well as a market index that is always fully invested. They recognize that maintaining diversification and risk controls can mean trailing stocks during strong rallies. And when a market pullback turns out to be temporary, they accept modest losses as the cost of being prepared should a more severe decline occur.
3. Acting before the danger arrives
Finally, “just in case” risk avoidance requires investors to put preventive tools in place before losses occur. Just as no one waits for an auto accident before buying insurance, investors can’t wait to add risk management beyond diversification until after the market loses 20% or more.
Risk is always with us in the financial markets. For that reason, risk-management tools are most effective when they are employed consistently—not added in reaction to losses.
Just in case a 10% “baby bear” turns into a “grizzly bear.”
Just in case a 20% downturn in an index fund turns into a 50% downturn.
Just in case the time required to get back to even takes years.
Dynamic risk management—just in case.