Most investors evaluate their portfolio based on their return, asking the basic question, “Did I make money?” While this is one way to judge your investments, it is also important to evaluate the level of risk you incur when pursuing those returns. The stock market is inherently volatile, as news, sentiment, fear and politics can all move the market one way or another. As long-term investors we aim to minimize the effect of volatility on a portfolio.
At Henssler Financial, we find the financial industry seems to confuse the terms “risk” and “volatility.” Volatility is the tendency for an investment’s value to soar or plummet; especially, when you’re talking about a short period of time. When our clients say, “I do not want to lose money,” that can be significantly different from volatility.
The industry uses a stock’s or portfolio’s standard deviation to measure volatility. However, a stock with frequent outperformance may have a standard deviation similar to one that frequently plummets. Since we seldom hear the complaint, “I’m making too much money,” it seems downside volatility is the concern. Other measures such as downside deviation can be used to better assess the risk of losing money. But let’s face it; these measures all focus on history, while the market is focused on the future.
There is no such thing as a riskless investment. Even if you invest in cash, you have risk of inflation. As prices go up, a cash investor looses purchasing power.
Investors need to consider their risk over the period they can afford to hold their investment. This is why we have our Ten Year Rule. Our Ten Year Rule philosophy states any money a client needs within 10 years should be invested in fixed-income securities, and any money not needed within 10 years should be invested in high quality, individual common stocks or mutual funds that invest in common stocks.
If an investor needs bonds to cover liquidity for 10 years from now and the market is down, the investor has the ability to wait a few years until the market comes back. The time horizon allows the investor to hold over the low times to sell when the market rises. When the market is up, we will sell some stocks to cover liquidity if that is what the client needs. This is how we control volatility in the portfolio. When you have a portfolio invested in fixed investments and equity investments, you should reduce the portfolio’s risk, as long as the fixed investments are held to maturity.
Just as the Ten Year Rule aims to minimize the effect of volatility to a portfolio as a whole, our strict investment criteria work to minimize the risk of the growth investments. Investors cannot pick a stock based on past performance, but past performance does provide a trend line, showing a stock’s highs and lows and how often it fluctuates. Bankruptcy risk, in our opinion, is the paramount risk when investing in the stock market. As a result, we choose to only buy companies that are ranked “A” or better for financial Strength by Value Line, “A-” or better for Earnings and Dividend Quality by Standards & Poor’s, or “2”or better for safety by Value Line.
Whatever your approach to risk, investors need to know it comes in many forms. You generally cannot reach your goals without incurring some investment risk; otherwise, you risk not reaching your goals.
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
